Nondisclosure Agreements And Insider Trading Risk

• Published date: 31 March 2022
• Subject Matter: Corporate/Commercial Law, Litigation, Mediation & Arbitration, Corporate and Company Law, Trials & Appeals & Compensation, Securities
• Law Firm: Morrison & Foerster LLP
• Author: Ronald G. White

Nondisclosure agreements (NDAs) are frequently used by corporations in connection with a host of different types of proposed transactions or relationships in order to safeguard their confidential information. But if a party to an NDA uses the information he or she obtains pursuant to the agreement to trade in the corporation's securities, has that party engaged in insider trading in violation of federal securities laws? The U.S. Court of Appeals for the Second Circuit addressed this question in a pair of recent cases and attempted to clarify this area of law. In United States v. Kosinski, 976 F.3d 135 (2d Cir. 2020), and United States v. Chow, 993 F.3d 125 (2d Cir. 2021), the court ruled that a party's trading in violation of an NDA requiring it to keep corporate information confidential'even if the NDA does not expressly prohibit such trading and even if the party is an outsider with an arm's-length relationship with the company' can constitute insider trading.

Insider Trading Law

Section 10(b) of the Securities Exchange Act of 1934 makes it unlawful to use a "manipulative or deceptive device or contrivance" in connection with the purchase or sale of securities in violation of Securities and Exchange Commission (SEC) rules. 15 U.S.C. ' 78j(b). In turn, SEC Rule 10b-5(a) prohibits the use of a "device, scheme, or artifice to defraud" in connection with the purchase or sale of securities. 17 C.F.R. ' 240.10b-5(a). In interpreting these broadly worded provisions, the Supreme Court has recognized two main forms of insider trading. Under the "classical" theory, a corporate insider violates the law if he or she trades on material, nonpublic information in violation of a fiduciary duty to the corporation's shareholders. United States v.

O'Hagan, 521 U.S. 642, 651 (1997). Under the "misappropriation" theory, a person violates the law "when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information." Id. at 652. To establish the "duty" required under the misappropriation theory, the government must show that the defendant had a "fiduciary relationship" or a similar "relationship of trust and confidence" with the source of the information. Id. at 652, 662 (citation omitted).

The issue of whether an agreement by a party to keep corporate information confidential gives rise to the type of "relationship of trust and confidence" required under the misappropriation theory is not a new question. For example, well-known entrepreneur and Dallas Mavericks owner Mark Cuban initially succeeded in having the SEC's high-profile insider trading case against him dismissed on the ground that an agreement not to disclose confidential information could not create such a relationship. SEC v. Cuban, 634 F. Supp. 2d 713, 725-26 (N.D. Tex.

2009). On appeal, the Fifth Circuit reversed and ruled that the case could go forward, holding that the SEC's complaint could be read to plausibly allege that Cuban agreed not to use the information in addition to agreeing not...