Summary of  Dirks v. SEC

Facts: Raymond Dirks was a securities brokerage firm officer in 1973.  Dirks received information from a former officer at the Equity Funding of America, asserting that the company was overstating its value.  After conducting numerous interviews with individuals at this firm, Dirks began alerting clients and friends of potential fraud by Equity Funding of America, who then made trades using that information.  When the company was found to have been involved in fraudulent activity, the SEC brought an action against Dirks for inside trader based on the knowledge he accumulated and then gave to friends and family.  The SEC found that Dirks was in fact guilty of inside trading, which the appeals court affirmed.  Dirks petitioned the Supreme Court to hear the matter.

Issue: The legal question presented was whether Dirks was appropriately categorized as an inside trader in light of the fact that the information gained did not lead to personal gain.

Holding: The Court held that Dirks did not fit the typical mold of an inside trader because he did not receive any personal gains.

Majority Opinion: The Court ruled that individuals who receive second-hand information (tippees) are only liable for insider trading if they had reason to believe that the individual from whom they received information (tipper) breached a fiduciary duty in disclosing sensitive/ confidential information and the tipper received any personal benefit from the disclosure.  Dirks had not been found to have personally benefitted from the disclosure so he did not fit the mold of a tippee.  Additionally, he used the information to expose fraud rather than conceal it.

Conclusion: This case was significant because it articulated the idea of “constructive insiders,” i.e. individuals such as lawyers, bankers, etc., who receive confidential information from a corporation while providing services to the corporation. Constructive insiders can be liable for insider trading violations “if the corporation expects the information to remain confidential, since they acquire the fiduciary duties of the true insider.”