WASHINGTON -- The Supreme Court ruled yesterday that the government has broad power to prosecute individuals who trade stock based on inside information about a company to which they have no direct ties.
The 6-3 ruling upheld a theory that the Securities and Exchange Commission has used for years to target investors who do not work for a company but who obtain private information about the company and use it to trade the stock. The theory is called the "misappropriation theory."
In a separate part of the decision, the court by a 7-2 vote upheld an SEC rule that bans buying or selling of stock in a company that is a target of a takeover bid, if the trading is based on "nonpublic information" about the bid.
Lawyer convicted
The theory and the rule were challenged unsuccessfully by a Minnesota lawyer who made more than $4.3 million by trading the stock of Pillsbury Co. based on information from his law firm when Pillsbury was a takeover target.
The attorney, since disbarred, is James Herman O'Hagan. He was convicted of 57 counts of fraud and money laundering, and was sentenced to three years and five months in prison and fined $150,000.
O'Hagan was not an insider with Pillsbury or with the company that made the takeover bid, Grand Metropolitan PLC, which his law firm represented.
True insiders are officers and directors of a company who trade on private information or who tip off others so they can trade on it. The SEC theory extends the ban on inside trading to outsiders, too.
The court conceded that the SEC theory goes beyond the language of securities fraud law. But it said the interpretation is a valid way to promote "honest securities markets and thereby promote investor confidence."
Justice Ruth Bader Ginsburg, who wrote the decision, said: "Investors likely would hesitate to venture their capital in a market where trading based on misappropriated nonpublic information is unchecked by law."
Lower courts split
When someone contrives to obtain inside information and uses it to trade securities, Ginsburg noted, other investors cannot protect themselves and thus face a serious disadvantage.
Under the theory at issue, someone who learns private $l information about a company is subject to securities fraud prosecution if, without telling the source of the information, that person trades on what was learned. Lower federal courts had divided on whether the misappropriation theory was valid under federal law. The justices ended that conflict by ruling in the SEC's favor.
They noted that, when O'Hagan obtained information from his firm about the takeover bid for Pillsbury, he came within the law's reach by using that information without the firm's knowledge to buy options and stock in Pillsbury.
The ruling did not, however, reinstate O'Hagan's conviction for misappropriating that information. The court said he still had other challenges that the lower court should consider when the case is returned there.
Nor did the court reinstate O'Hagan's conviction for violating the SEC's rule against trading by anyone with inside information about a takeover offer. The justices noted that O'Hagan has other challenges to make to his conviction for breaking that rule.
Mandatory contribution
In a separate ruling yesterday, the court by a 5-4 vote upheld the power of the Agriculture Department to require handlers of fruits and other farm-grown foods to contribute to an industry fund to encourage consumers to buy that industry's products.
The decision appears to uphold advertising campaigns that are used to promote beef and milk, as well as fruits and vegetables.
The court rejected a claim by some of the handlers of California tree-grown fruits -- peaches, plums and nectarines -- that the advertising campaign ordered by the Agriculture Department violated their free speech rights.
Pub Date: 6/26/97
