Did Bauer commit securities fraud by trading on her knowledge, as a participant in directors’ meetings etc, of the severity of Heartland’s liquidity crunch? Under the classical insider trading theory, §10(b) of the pertinent statute is violated “when a corporate insider trades in the securities of his corporation on the basis of material, nonpublic information.” This is a “deceptive device” because it breaches the relationship of trust between shareholders and insiders.
The district court seems to have relied on that notion, writing when it granted summary judgment that “the parties agree that Bauer was an insider at the time of her trade.”
The problem, though, is that in contrast to a typical trade in the stock of a public corporation, a mutual fund redemption is not a transaction between an insider on the one hand and an outsider, a dupe, on the other. No, the counterparty in redemption is by definition to mutual fund itself, an insider as to its own affairs. The fund “cannot be duped by nondisclosure,” the opinion says, so the traditional argument is at best an awkward fit.
The SEC on appeal pressed the more recent alternative theory in insider-trading law, misappropriation, as in the O’Hagan case. Indeed, it pressed this view so exclusively that the appellate court deemed the agency to have “abandoned and forfeited the classical theory as a basis for liability in this case.
The misappropriation theory would hold that liability is appropriate because Bauer misappropriated confidential information that she received – at the board of directors’ meeting for example – in breach of a duty owed to the source of that information.
But this theory was never properly presented to the district court, so there is no proper record on appeal. Hence the remand: the SEC can try again. And that will be worth watching.