Misappropriation Theory and Outsiders' Insider Trading Liability in Hong Kong


Student thesis: Doctoral Thesis

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Awarding Institution
Award date28 Aug 2019


According to David S. Ruder as Chairman of the US Securities and Exchange Commission, insider trading refers “generally to the act of purchasing or selling of securities, in breach of fiduciary duty, by persons who possess material, non-public information about the issuer or its securities.” Traditionally, the determinants in constitution of insider trading include (i) purchasing and selling of listed securities (including stocks and derivatives); (ii) breach of fiduciary duty; (iii) person possess of; (iv) material, non-public information. Nevertheless, it appears that most of the scholarly studies in respect of insider trading have been emphasized on the corporate insider’s responsibility owed to the issuer or the source information of the related listed securities. While the concept on deterrence of insider trading has already been well-established in Hong Kong and other major jurisdictions, it is observed that the securities regulation as well as the relevant legal principles relating to this type of market misconduct has been less straightforwardly applied on an outsider, who is not a substantial shareholder, director or employee of the corporation or a related corporation of the corporation and without involvement of fiduciary duty incurred thereon. Unlike the traditional fiduciary duty theory, the conceptual basis in pursuance of outsider’s liability on insider trading seems incomplete in view of the controversial judicial decisions. Thus, these indeterminate areas on securities regulation become the core research issue in this thesis.

In fact, it is observed that the current securities regulation in respect of insider trading has placed substantial reliance on the existence of fiduciary duty as a prerequisite to constitute insider trading. Does the breach of fiduciary duty represent a definite requirement to constitute liability on insider trading? What will happen if an alleged defrauder does not incur any fiduciary duty to the issuer or the source of inside information? Hence, the focus of this thesis will be placed on outsider’s liability in Hong Kong with reference to the relevant legal theories derived from the corresponding landmark judicial decisions in the United States. Whereas the theory of fiduciary duty has been a well-established conceptual framework in respect of insider trading, the situation would become blurred to pursue an outsider’s liability provided that no fiduciary duty is incurred thereon. In order to tackle with this legal problem with respect to the outsider’s liability, the misappropriation theory has been initiated in the US case of Newman on the basis of the concept of theft of information. Unlike the traditional fiduciary duty theory, the misappropriation theory has sometimes been criticized as lack of adequate conceptual basis. It is also observed that the forthcoming judicial decisions in the US were reluctant to adopt the misappropriation theory without fulfilling the element of fiduciary duty by the alleged defrauder. Concerning the difficulties in forming an appropriate conceptual framework to pursue an alleged defaulting outsider’s liability on insider trading, it becomes the critical contribution of this thesis in remedying the uncertainties within the misappropriation theory especially relating to its applicability on outsiders without the relevant fiduciary duty to the issuer or the source of information.

To order to resolve the conceptual incompleteness of the current misappropriation theory, the remedial framework proposed in this thesis has also been made with reference to the Ninth Circuit’s decision in SEC v. Clark. According to Clark, the applicability of misappropriation theory for outsider’s insider trading liability would depend on three requirements, including (i) misappropriation of material, non-public information; (ii) a relationship of trust and confidence; and (iii) use of information for securities transaction. With respect to the requirement of misappropriation of material, non-public information, it is necessary to establish a more generally acceptable standard or approach in defining the meaning of “material, non-public” information. While the definition of non-public is less controversial, the prevailing securities regulation is lack of sufficient and precise interpretation on the meaning of “material” information in the context of insider trading. The clarification on this standard of materiality is especially important because the information being misappropriated under the misappropriation theory must be material to the price change of the listed securities concerned if make it available to the public investors. Hence, this thesis would propose another standard of materiality which is specifically designated for the comprehensive circumstances of securities market, instead of applying the ordinary standard of “reasonable person” test in a general manner. Also, a dual-track model in determination of materiality standard by taking into account of both qualitative and qualitative approaches is recommended. In order to mitigate the effect of legal circularity as an undesirable outcome of the reasonable person test, the “specialist prudent person” standard, culpability-related function of objectivity, cost-and-benefit approach and materiality guidance, etc. are all proposed in this thesis to strike for a balance to come into an appropriate material standard specifically designed from the perspective of insider trading.

Concerning the requirements for imposing insider trading liability on an outsider associated with (i) a relationship or trust and confidence; and (ii) the use of inside information for the relevant securities transaction, this thesis would explore the possibility in applying the concept of securities fraud and deception to substitute for the condition of fiduciary duty. In short, it is proposed a fraud-based approach with reference to other insider trading theories in the US, including the misrepresentation theory and the affirmative misrepresentation theory, to fill up the misappropriation theory’s conceptual gap in respect of non-existence of outsider’s fiduciary duty or duty of disclose or abstain. More particularly, the special affirmative relationship as substitution of fiduciary duty will be based on an outsider’s wrongful misrepresentation to obtain insider information from its source in a willful and fraudulent manner. Considering that both willfulness and fraudulent intent are the essential determinants of affirmative duty, a discussion on the applicability of knowledge, willfulness or intentional act rather than simply use or possession of inside information as requirement under the misappropriation theory will also be analyzed.

To sum up, the US misappropriation theory has already been cited as referencing conceptual basis by the judiciary in Hong Kong to pursue outsider’s insider trading liability in dealing with the listed securities on the ground of material, non-public information. In this regard, the core research significances of this thesis are to tackle with the ambiguity on the constituents of the misappropriation theory and to serve as a valid conceptual basis to enhance its applicability in pursuing outsider’s insider trading liability in Hong Kong.