The Misappropriation Theory of Insider Trading: Its Past, Present, and Future

Troy Cichos*

I. INTRODUCTION It happens all the time, without a second thought. People on the golf course, at the weekly card game, or at a backyard barbecue, pass on hot stock tips to friends and relatives. If asked about the possibility of violating insider trading laws, the following responses would be typical: "It could never happen to me," and "it's only a problem for large, powerful investors." These responses, while typical, are wrong. Just ask Carl Reiter. One day on the golf course, one of Reiter's oldest friends advised him to buy stock in Revco Drug Stores; the friend knew "the guy doing ."' Reiter, a real estate developer, invested a few thousand dollars in the stock, made a profit of $2,625 in two months, and thought the investment was over. It was not. Two years later, one of Reiter's golfing partners got a phone call from a person claiming to be an investigator for the Securities and Exchange Commission (SEC). The friend's response was "yeah, right, and I'm Ivan Boesky." The person was an investigator, and Reiter and the other golfers who acted on the stock tip were charged with violating insider trading laws.2 Reiter eventually disgorged his profits resulting from the tip and paid a fine of the same amount.' Reiter was shocked that the powerful SEC was concerned about his small investment and that insider trading laws applied to such conduct. The actions of the SEC in this case, however, are not unusual. The scope and application of

* J.D.; 1995, Seattle University School of Law, B.S. Finance 1990, University of Utah. I would like to thank Professor Kellye Testy for all of her advice and comments during the drafting and editing of this Article, the committee members on the Review who participated inthe pre- production editing of this Article, and Allison Wheeler for being so supportive during the writing, editing, and publication processes. 1. Thomas E. Ricks, How 4 Pals Who Mixed Golf and Stock Tips Landed in the Rough, WALL ST. J., July 21, 1989, at Al. 2. Id. 3. Id. 4. Id. at A6. Seattle University Law Review [Vol. 18:389

insider trading have expanded the concept to a point that it is no longer limited to actual insiders and can affect any person who trades in securities? "Insider trading" is neither defined nor expressly prohibited by federal securities laws.6 Rather, the Securities and Exchange Act of 1934 (Act) broadly proscribes "deceptive" practices in connection with the purchase or sale of securities.7 Section 10(b) of the Act gives the SEC authority to promulgate rules and regulations to achieve those aims." Pursuant to this authority, the SEC adopted Rule 10b-5, which prohibits fraudulent and deceptive practices in the trading of securi- ties.' These two legislative and administrative enactments are the vehicles through which insider trading is prohibited and enforced. 10 Because the prohibition against deceptive practices is broad, and because insider trading has not been specifically defined by Congress, the SEC and the judiciary have defined insider trading." Unfortu- nately, this process has led to conflicting views of insider trading and to decisions based primarily on the facts of each case, rather than upon a bright line rule. 2 Moreover, the courts and the SEC do not always

5. See Barbara B. Aldave, The Misappropriation Theory: Carpenter and Its Aftermath, 49 OHIO ST. L.J. 373 (1988). 6. Audrey Strauss & Lisa Fishbone, Insider TradingAfter Chestman, 793 PLI/CoRP. 365, *2 (1992), available in WESTLAW, Pli-Corp Library (pinpoint page numbers refer to WESTLAW pagination). 7. 15 U.S.C. § 78j(b) (1988); see also Strauss & Fishbone, supra note 6, at *1. Section 10(b) prohibits the use in "connection with the purchase or sale of any security ... any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe .. " 15 U.S.C. § 78j(b). 8. 15 U.S.C. § 78j(b)