The Supreme Court delivered a blow to the Securities and Exchange Commission yesterday by rejecting its censure of Raymond L. Dirks, who exposed the 1973 Equity Funding scandal, along with the insider-trading theory that the agency used to move against him.
The court said it is not a crime to leak confidential corporate information for the sole purpose of of exposing fraud.
The 6-to-3 ruling went well beyond the unusual facts of the Dirks case to establish guidelines on the long-disputed legal responsibilities of all those who make their living analyzing Wall Street--broker-dealers, securities analysts and others who come into possession of information not generally available to the trading public.
Justice Lewis F. Powell, writing for the court, said leaking confidential corporate information is not a violation of the securities law unless done by someone who breaches his legal responsibility to shareholders with the motive of personal gain. Disclosure with the motive of exposing fraud is not illegal, the court said.
The recipient of such information, like Dirks (or any other analyst) cannot be held liable so long as the person who gave it to him is not culpable, the court said.
The SEC had urged a much stricter interpretation that was opposed even by the Justice Department. That approach, as Powell described it, permitted the SEC to move against anyone who knowingly received nonpublic information and traded on it. The SEC's rule "would have no limiting principle," Powell said.
The case stems from one of the largest corporate frauds of all time. Equity Funding Corp. of America stunned competitors during the 1960s by transforming itself almost overnight from a small Los Angeles insurance agency to a billion-dollar financial congolmerate.
Dirks was a New York securities analyst at the time. In March 1973, Ronald Secrist, a former Equity Funding vice president, came to Dirks and told him that Equity Funding was a fraud based on phony insurance policies. Dirks eventually went to law enforcement authorities and to the Wall Street Journal. Before he did this, however, he told five institutional investors, who unloaded more than $17 million of worthless stock to unsuspecting purchasers.
For this, the SEC charged Dirks with violations of securities laws through the use of inside information. His censure was upheld by the U.S. Court of Appeals for the District of Columbia, which the justices reversed yesterday.
The case took on added significance because of uncertainties in the interpretation of a 1980 Supreme Court decision, Chiarella vs. U.S., over the question of just who is an "insider" for purposes of the law and therefore must abstain from trading on nonpublic information. The answer to that question was crucial in determining Dirks' responsibility.
Quoting the Chiarella ruling, Powell said an insider is an agent of the corporation and its shareholders, a "fiduciary" in whom the sellers of securities have "placed their trust and confidence." It is not just someone--an analyst or anyone else--who has received confidential information, Powell said.
A violation consists, in part, of breaching that trust. But that alone is not sufficient. "All disclosures of confidential corporate information are not inconsistent with the duty insiders owe to shareholders," he said.
"The test is whether the insider personally will benefit, directly or indirectly, from his disclosure," Powell said. "Absent some personal gain, there has been no breach of duty to stockholders." He said that the SEC must detrermine "whether the insider's purpose in making a particular disclosure is fraudulent."
Secrist, and others who told Dirks about the scandal, were not motivated by personal gain. They were "motivated by a desire to expose fraud," he said.
Dirks cannot be guilty if the tippers are not guilty, Powell said. A tippee, like Dirks, "assumes a fiduciary duty to the shareholders of a corporation not to trade on material nonpublic information only when the insider has breached his fiduciary duty to the shareholders by disclosing the information" and only when the tippee "knows or should know that there has been a breach."
Imposing liability "solely because a person knowingly receives" information and trades on it ". . . could have an inhibiting influence on the role of market analysts. . . ," Powell said.
David Bonderman, Dirks' lawyer in the case, praised the ruling yesterday, saying it affords greater freedom both to analysts and to "other professionals who go out and find things and use them. . . . We are very pleased that, after 10 years of litigation, Dirks' conduct has finally been vindicated."
Justice Harry A. Blackmun, joined by Justices William J. Brennan, Jr., and Thurgood Marshall dissented in Dirks vs. SEC.