Case 17.3
UNITED STATES V. O’HAGAN
Supreme Court of the United States
521 U.S. 642; 117 S. Ct. 2199; 1997 U.S. LEXIS 4033 [June 25, 1997]
FACTS:
Respondent James Herman O’Hagan was a partner in the Law firm of Dorsey & Whitney in
Minneapolis, Minnesota.
In July 1988, Grand Metropolitan PLC (Grand Met), a company based in London, England, retained
Dorsey & Whitney as local counsel to represent Grand Met regarding a potential tender offer for
the common stock of the Pillsbury Company, headquartered in Minneapolis.
Both Grand Met and Dorsey & Whitney took precautions to protect the confidentiality of Grand
Met’s tender offer plans. O’Hagan did no work on the Grand Met representation.
Dorsey & Whitney withdrew from representing Grand Met on September 9, 1988.
Less than a month later, on October 4, 1988, Grand Met publicly announced its tender offer for
Pillsbury stock.
On August 18, 1988, while Dorsey & Whitney was still representing Grand Met, O’Hagan began
purchasing call options for Pillsbury stock. Each option gave him the right to purchase 100 shares
of Pillsbury stock by a specified date in September 1988.
Later in August and in September, O’Hagan made additional purchases of Pillsbury call options.
By the end of September, he owned 2,500 unexpired Pillsbury options, apparently more than any
other individual investor. O’Hagan also purchased, in September 1988, some 5,000 shares of
Pillsbury common stock, at a price just under $39 per share.
When Grand Met announced its tender offer in October, the price of Pillsbury stock rose to nearly
$60 per share. O’Hagan then sold the Pillsbury call options and common stock, making a profit of
more than $4.3 million.
The Securities and Exchange Commission (SEC) initiated an investigation into O’Hagan’s
transactions, culminating in a 57-count indictment.
The indictment alleged that O’Hagan defrauded his law firm and its client, Grand Met, by using for
his own trading purposes material, nonpublic information regarding Grand Met’s planned tender
offer.
PROCEDURE: A jury convicted O’Hagan on all counts, and he was sentenced to prison. The Court of
Appeals for the Eighth Circuit reversed all of respondent’s convictions for securities fraud.
ISSUE: Did O’Hagan through the trading of securities violate Section 10(b) and Rule 10b-5 when he
misappropriated nonpublic information for his personal benefit?
RULE: “Under the ‘traditional’ or ‘classical theory’ of insider trading liability, Section 10(b) and Rule
10b-5 are violated when a corporate insider trades in the securities of his corporation on the basis of
material, nonpublic information.”
REASONING:
1. In lieu of premising liability on a fiduciary relationship between company insider and purchaser or
seller of the company’s stock, the misappropriation theory premises liability on a fiduciary-turned-
trader’s deception of those who entrusted him with the access to confidential information.
2. The misappropriation theory is designed to protect the integrity of the securities market against
abuses by outsiders to a corporation who have access to confidential information that will affect
the corporation’s security prices when revealed, but who are no fiduciary or other duty to that
simultaneously harms members of the investing public.
ADDITIONAL INFORMATION:
“The ‘misappropriation theory’ holds that a person commits fraud ‘in connection with’ a securities
transaction, and thereby violates Section 10(b) and Rule 10b-5, when he misappropriates
confidential information for securities trading purposes, in breach of a duty owed to the source of
the information.”
Full disclosure forecloses liability under the misappropriation theory: Because the deception
essential to the misappropriation theory involves feigning fidelity to the source of information, if