James O’Hagan was a partner in the law firm of Dorsey & Whitney in Minneapolis, Minnesota. In July 1988, the London-based company Grand Metropolitan PLC (Grand Met) retained Dorsey & Whitney as local counsel for 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, who was not working on the deal, began purchasing Pillsbury stock and call options for Pillsbury stock. When Grand Met announced its tender offer in October, the price of Pillsbury stock rose to $60 per share. O’Hagan sold his Pillsbury call options and stock, making a profit of more than $4.3 million.
The Securities and Exchange Commission (SEC) initiated an investigation into O’Hagan’s transactions that culminated in a fifty-seven-count indictment, charging O’Hagan with, among other counts, violation of Rule 14e-3(a). Rule 14e-3(a) was adopted by the SEC pursuant to Section 14(e) of the Securities Exchange Act of 1934. Section 14(e) reads in relevant part:
It shall be unlawful for any person . . . to engage in fraudulent, deceptive, or manipulative acts or practices, in connection with any tender offer. . . . The [SEC] shall, for the purposes of this subsection, by rules and regulations define, and prescribe means reasonably designed to prevent, such acts and practices as are fraudulent, deceptive, or manipulative.
Relying on Section 14(e)’s rulemaking authorization, the SEC promulgated Rule 14e-3(a) in 1980. Traders violate Rule 14e-3(a) if they trade on the basis of material nonpublic information concerning a pending tender offer that they know or have reason to know has been acquired “directly or indirectly” from an insider of the offeror or the target, or someone working on their behalf. Rule 14e-3(a) requires traders who fall within its ambit to abstain from trading or to disclose the nonpublic information, without regard to whether the trader owes a preexisting fiduciary duty to respect the confidentiality of the information. In contrast, courts have interpreted Section 14(e) to apply only to situations in which the person trading violated a fiduciary duty by trading. Did the SEC exceed its rulemaking authority by adopting Rule 14e-3(a) without requiring a showing that the trading at issue entailed a breach of fiduciary duty? [United States v. O’Hagan, 521 U.S. 642 (1997).]