February 16, 2006
Civil Insider Trading Charges Dismissed for Lack of Fiduciary Duty
A federal judge in Los Angeles dismissed the SEC's insider trading complaint against J. Thomas Talbot because the Commission did not adequately allege a breach of fiduciary duty to support the charges. Talbot was a director of Fidelity National Financial Inc., which owned 12% of the shares of Lending Tree Inc., then a publicly-traded company. In 2003, Talbot learned from Fidelity National's CEO at a company board meeting that Lending Tree would be bought by USA Interactive at a premium to its market price. Talbot purchased 10,000 shares of Lending Tree over the next week and then sold them after the announcement, realizing profits of over $67,000. According to the SEC's Litigation Release (here):
At the Fidelity Board meeting, the Complaint alleges, Talbot heard the CEO's comments about the potential acquisition, and wrote "LendingTree" on the top of his meeting agenda. These words constituted the only notes that Talbot made during the four-hour Board meeting. The Complaint alleges that after this information was conveyed to the Board of Directors, a Fidelity Board member cautioned the directors not to trade in LendingTree securities because they had been provided with confidential information.
The SEC accused Talbot of insider trading, alleging that his position as a director of Fidelity National and the admonition not to trade created the fiduciary duty necessary to support an insider trading case. According to a Los Angeles Times article (here), the district judge dismissed the case because Talbot did not owe a fiduciary duty to Lending Tree, the original source of the information.
While the information is sketchy, it appears that the SEC sued under the misappropriation theory endorsed by the Supreme Court in U.S. v. O'Hagan, 521 U.S. 642 (1997), which permits an insider trading case under Section 10(b) and Rule 10b-5 to proceed so long as the government proves that the trader breached a fiduciary duty by trading the securities, not necessarily one owed to the company whose shares were traded. The judge, however, seems to be applying the narrower rule of Chiarella v. U.S., 445 U.S. 222 (1980), which requires that the trader owe a fiduciary duty or "other duty of trust and confidence" to the issuer of the securities traded, in this case Lending Tree. It is hard to tell whether the district court somehow rejected the SEC's misappropriation claim, or found it unsupportable. The SEC's position on misappropriation, as spelled out in Rule 10b-5-2 (here), is quite broad, that a "duty of trust and confidence" is created in the following circumstances:
(1) Whenever a person agrees to maintain information in confidence;
(2) Whenever the person communicating the material nonpublic information and the person to whom it is communicated have a history, pattern, or practice of sharing confidences, such that the recipient of the information knows or reasonably should know that the person communicating the material nonpublic information expects that the recipient will maintain its confidentiality
Talbot would seem to come within this definition, although whether Rule 10b-5-2 is consistent with the Supreme Court precedents in the area is another question. I'm not aware of any opinions that have considered the validity of the SEC's definition, and it may not be an issue in this case because the presentation of the information to a director seems to fit within the standard view of a fiduciary duty, so this broader definition may not even be needed to bring Talbot within the insider trading prohibition. The SEC may well appeal in this case. (ph -- thanks to Peter Lattman on the Wall Street Journal Law Blog (here) for noticing the district court's decision)
UPDATE: A Wall Street Journal article (here) sheds a bit more light on the case, noting that Lending Tree and Fidelity National did not have a confidentiality agreement in place. Nevertheless, for the purposes of the misappropriation theory of insider trading liability, it may be that the duty owed by Talbot as a director of Fidelity National to maintain the confidentiality of information received through that company could be the basis for insider trading charges. No word yet on whether the SEC will appeal. (ph)
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Very interesting case. In footnote 91 of the court's decision, it said that Rule 10b5-2 does not apply because the rule was not intended to apply to business relationships, citing the SEC Release. I believe this is the first court to say this. Says even if it did apply, result would not change, as no express agreement or history of sharing confidences. Instead the court applies the law as stated by Chestman, Cassesse, and Kim, finds there was no relationship of trust and confidence between Fidelity and Lending Tree
Posted by: jsa | Feb 16, 2006 12:21:11 PM