In SEC v. Talbot, 2008 WL 2574513 (9th Cir. June 30, 2008), the United States Court of Appeals for the Ninth Circuit held that a board member could be liable for insider trading under the “misappropriation theory” where the board member owed no fiduciary duty to the company whose stock he traded. This holding reversed summary judgment granted in favor of the board member, and broadened the scope of potential liability for misappropriation of information by board members and officers of companies.
Defendant J. Thomas Talbot, a businessman and attorney, served on the board of Fidelity National Financial, Inc. Fidelity owned approximately a 10% interest in LendingTree, Inc., an online lending and realty services exchange that is publicly traded on NASDAQ. In a Fidelity board meeting, Fidelity’s CEO announced the possibility that LendingTree would be acquired. The CEO informed the Board that LendingTree would not disclose the name of the acquirer, but that Fidelity stood to make a substantial profit from the acquisition as a result of its LendingTree stock holdings. Talbot’s story regarding the certainty of the acquisition expressed at the board meeting differed substantially from that of the other board members. Whereas Talbot categorized the acquisition as merely a “rumor” and definitely not a sure thing, the other board members understood the acquisition to be “far along” or at the “advanced discussion” phase. All of the board members present at the meeting, except for Talbot, considered the LendingTree information to be confidential.
Two days after the meeting, Talbot purchased 5,000 shares of LendingTree. After LendingTree’s share price rose during the following week, Talbot purchased an additional 5,000 shares. Five days later, LendingTree and its acquirer issued a press release announcing the acquisition, and LendingTree’s stock rose roughly 41% on the news. Immediately thereafter, Talbot sold all of his LendingTree shares for a profit of $67,881.20. The SEC commenced an investigation into Talbot’s trading activities about five months later and brought a civil action against Talbot for insider trading.
The district court granted Talbot’s motion for summary judgment, holding that Talbot would only be liable under the “misappropriation theory” if Talbot or Fidelity owed a fiduciary duty of confidentiality to LendingTree, the “originating source” of the information on which Talbot traded. The district court held that the SEC did not meet its burden of proving that Talbot, Fidelity, and LendingTree were “linked through a continuous chain of fiduciary relationships” and thus that Talbot could not be liable. The district court also found a genuine issue of material fact as to whether the information on which Talbot traded was material.
On appeal, the Court of Appeals first examined the theories of insider trading, starting with the “classical theory” and its limitations, followed by the development of the “misappropriation theory” recognized in United States v. O’Hagan, 521 U.S. 642 (1997). The Court then noted that Talbot could only be liable, if at all, under the misappropriation theory. The Court stated that for the SEC to prevail on appeal, it had to demonstrate that (1) Talbot breached a fiduciary duty arising from a relationship of trust and confidence owed to the source of the information on which he traded; and (2) the information on which Talbot traded was material.
The Court then held that Talbot could be liable under the misappropriation theory because he had a duty to Fidelity to keep the information about the LendingTree acquisition confidential, and because he secretly breached that duty by trading in LendingTree stock for personal profit. The Court, relying on the Supreme Court’s decision in O’Hagan, held that “a continuous chain of duties is not a requirement for liability to attach under the misappropriation theory” and that the district court “misinterpreted the misappropriation theory as requiring that the duty of confidentiality be owed to the ‘originating source’ of the information.” The Court labeled Talbot’s conduct as “textbook misappropriation” because Talbot owed a duty of trust and confidence to Fidelity as a member of its board, and Fidelity was also the source of the information on which he traded. The information was confidential because it was property “entrusted” to him by Fidelity in his capacity as a board member.
The Court disagreed with Talbot’s argument that no reasonable factfinder could conclude that Talbot was obligated to keep the information confidential, noting that nearly seven decades of Delaware law support the principle that corporate officers and directors cannot use their positions of trust and confidence to further their private interests. The Court also disagreed with Talbot’s argument that the information on which he traded was not confidential based upon his belief that the LendingTree information was merely a rumor and the CEO did not indicate the information was confidential. The Court held that “as a matter of law, the very nature of the information on which Talbot traded was confidential.”
The Court found that Talbot’s conduct fell squarely within the range of conduct sanctioned in O’Hagan, and held that, as a matter of law, Talbot was liable under the misappropriation theory of insider trading. The Court did, however, hold that the district court did not err in finding a genuine issue of material fact regarding the materiality of Talbot’s misappropriation.
The holding in Talbot reminds corporate directors to exercise extreme caution in trading on information provided to them in a board setting, even if that information relates to other companies such as clients and customers.