Like you, I’m sure the SEC would take the position that the trade contemplated by The Ethicist constitutes securities fraud under the misappropriation theory. I don’t really care what the SEC thinks. The SEC has, from the get-go, attempted to expand the scope of the insider trading prohibition. The Supreme Court, though, has consistently said (most notably, in O’Hagan) that there can be no Section 10(b)/Rule 10b-5 liability absent a deception.

I therefore disagree with your initial assertion that the fraud in a misappropriation “is not the lie, it is the breach of a confidential relationship.” The O’Hagan court made crystal clear that the deception in a misappropriation case is using confidential information to your benefit while you’re saying that you’re NOT doing so. That’s a lie, and it thus violates Rule 10b-5.

If you’ve never said that you’re not using confidential information for your benefit, then your doing so can’t be a lie. Doctors represent to their patients that they’re not disclosing confidential information (so disclosure might constitute fraud). But, at least according to The Ethicist, they don’t make a similar representation that they’re not using such information for their benefit. If that’s right (and there’s no contractual assurance to that effect), the trading at issue here would not involve a lie. O’Hagan says that if there’s no such lie, there’s no insider trading liability.

I’m not familiar with the details of Materia, but, assuming it’s inconsistent with the analysis I’ve presented here, I’d consider it (like Willis) to have been preempted by O’Hagan.

The original misappropriation theory case (on the civil side) was Materia – a proofreader in a financial printing firm. He was accused of figuring out the targets of tender offers and trading on that information. Information that he “stole” from his employer, with whom he had a fiduciary duty, and the employer had a fiduciary duty to the offeror.

I do not think there is any doubt that the SEC would take the position that a doctor has a duty to keep his patient’s confidences, and not to use those confidences for his personal gain. Therefore, like Materia, and he breached that duty when he obtained the information and purchased (or sold) the security.

I am not familiar with Willis, and while it may predate O’Hagan, it does not predate Materia, nor the other decisions in the circuits that adopted the misappropriation theory, which ultimately led to O’Hagan.

Materia never promised anything to his employer, just as our doctor never promised anything to his patient. The obligation that they both have in common however, is to protect the confidences of their employer (patient).

I certainly agree with Professor Lambert regarding the SEC’s authority to enact rules which change the meaning of the statute, but given the long line of misappropriation cases, does the SEC even need that statute?

The courts effectively wrote the “fraud in connection with” requirement of 10b out of the statute. As it stands today, the statute is applied as if it says a “fraud that results in the purchase or sale of a security.”

Is it such a stretch to call the violation of the doctor-patient privilege a fraud?

I’m not persuaded by the Willis decision, as it pre-dates O’Hagan and seems to assume that the gravamen of a misappropriation offense is some kind of breach of the duty of confidence. It is not. It is saying one thing (”I won’t use your information to profit”) and secretly doing another. Apparently (if what The Ethicist says is right), the doctor here never said he wouldn’t use his patient’s information for personal profit, though he undoubtedly promised not to disclose the information.

With regard to the relevance of Rule 10b5-2, see my previous comment. The SEC cannot, via rule promulgated pursuant to its authority under Section 10(b), create duties not to use confidential information for profit. Those duties are a matter of state law, ethical codes, and/or contract.

A pertinent extract from the SEC release follows:

n109 Proposed para. (b) does not enumerate relationships that existing case law already recognizes as providing a clear basis for misappropriation liability: for example, lawyer-client, O’Hagan; employee-employer, Carpenter, psychiatrist-patient, United States v. Willis, 737 F. Supp. 269 (S.D.N.Y. 1990), appeal dismissed, 778 F. Supp. 205 (S.D.N.Y. 1991). As the O’Hagan case demonstrates, an individual working at a professional firm may be liable for misappropriating information about a particular matter even if he or she is not personally working on that matter.

The SEC cannot, however, expand the scope of Section 10(b) via rule. Section 10(b) outlaws only deception. The deception at issue in a misappropriation case is “two-facedness”: The trader tells the source that he won’t use the source’s information, but he then turns around and secretly does so.

Thus, to give rise to misappropriation liability for use of the source’s information, the relationship at issue must not simply be one of trust and confidence (where telling the information to another would be a breach of trust), it must also be one in which the recipient of the information has somehow represented or implied that he will not USE the information for personal profit.

The SEC is likely trying to use Rule 10b5-2 to read into non-fiduciary trust relationships some implicit representation that the information exchanged will not be used for personal profit. But the commission’s enabling legislation — Section 10(b) — likely does not give it the authority to determine the substance of the underlying duties whose clandestine violation constitutes fraud. Those duties are determined by (state) fiduciary duty law, private contract, and perhaps rules of ethics.

For use of confidential information to constitute deception, which is required by Section 10(b), there has to be a relationship of trust or confidence where one aspect of that trust/confidence is an assurance that information conveyed will not be used to personal advantage. The Ethicist says that medical ethics do not imply this sort of assurance on the part of a doctor (”Medical ethics do not forbid this trade.”). If that’s right — and I have no idea if it is or isn’t; I’m taking The Ethicist at his word — then there’s no assurance by the doctor that he won’t use the information to personal advantage, and his doing so without disclosing his plans thus cannot constitute deception.

So perhaps I am saying that, in the context of a non-familial, non-fiduciary doctor/patient relationship, the duty not to benefit from the patient’s information must come either from contract, or perhaps from the medical center’s internal rules (which also presumably wouldn’t forbid the trade here; otherwise the doctor’s question of The Ethicist would be too easy), or from background ethical rules. We can eliminate the first two sources of duty, and The Ethicist has eliminated the third. There thus is no duty not to use the information, so secretly doing so can’t be fraud.

Of course, as I said before, I’d never advise a client to make this trade. The SEC would be all over it. As a strict legal matter, though, The Ethicist’s legal analysis — no ethical barrier, but potential misappropriation liability — seems wrong.

This might make a good exam question, no?