In yesterday’s New York Times Magazine, an anonymous reader posed the following question to The Ethicist:
I am a subspecialty physician without primary responsibility for patients. I consulted on the care of the C.E.O. of a major company, the seriousness of whose illness was not being fully disclosed to shareholders. I own stock in this company. Once I complete my consultation, may I ethically sell my shares, motivated by the information I gained as a doctor?
The Ethicist responded that “[m]edical ethics do not forbid this trade, but investor ethics — a curious phrase, given recent headlines — do, so you may not make this sale.” The Ethicist went on to explain that the trade would likely be deemed illegal insider trading under the misappropriation theory.
This response — medical ethics present no bar to this trade, but the misappropriation theory does — cannot be right. Here’s why:
Insider trading is illegal, the courts reason, because it amounts to fraud in connection with the sale or purchase of a security. Fraud, of course, is lying. But where’s the lie when one merely purchases or sells a stock on an anonymous exchange? There’s no affirmative misstatement (the trader never says anything at all, other than “I’d like to purchase (or sell) x shares of y stock”). The lie must therefore be a failure to speak. Such an omission, though, cannot be considered a lie unless the “non-speaker” has some duty to speak.
Courts have recognized two theories under which such a duty may arise. Under the “classical theory,” the duty to speak arises because the trader is a fiduciary of her trading partner. Thus, an insider of a company must speak (specifically, must disclose her material non-public information) before buying company stock from an incumbent shareholder, to whom she owes fiduciary duties. Her failure to speak in the face of this duty would constitute the “lie” necessary for securities fraud. Under the “misappropriation theory,” the duty arises because of the relationship between the trader and the source of her non-public information. If the trader has essentially promised the source of her information that she won’t use the source’s information to her advantage, then trading on the information without first telling the source of her intention to do so would amount to fraud. As the Supreme Court put it, “the deception essential to the misappropriation theory involves feigning fidelity to the source of information.” United States v. O’Hagan, 521 U.S. 642, 655 (1997).
So how does this complicated (and sort of silly) body of law apply to the doctor’s dilemma? There’s clearly no duty to speak under the classical theory, for the doctor is not an insider of the corporation at issue and thus owes no fiduciary duty to his trading partner. The Ethicist says liability would arise under the misappropriation theory. But misappropriation liability requires “feigning fidelity to the source of information” — i.e., saying you won’t personally profit from the source’s information but then turning around and doing so without disclosing your plans. There could be no liability, then, unless the doctor had essentially told his patient that he wouldn’t use the patient’s information.
Now, if the doctor were a fiduciary of the patient, such an assurance (“I won’t use your information for my profit”) would be implied by the law, for the law imposes duties of undivided loyalty on fiduciaries. But the doctor/patient relationship, while certainly a relationship of trust and confidence, is not technically a fiduciary relationship. Thus, the duty not to use a patient’s information for personal profit must come from elsewhere. It could, of course, arise from contract (i.e., the contract might say or imply that the doctor won’t use the patient’s information). We can assume, though, that no such contractual provision existed here; otherwise, the doctor’s question to The Ethicist would’ve been a pretty easy one (it’s generally unethical to break your promises). Finally, the duty could arise from the background rules of ethics governing the doctor/patient relationship. The Ethicist, though, says the rules of medical ethics would not forbid the doctor’s trade.
If The Ethicist is right on this point, then the doctor (1) has no fiduciary duty not to use the information, (2) presumably didn’t contractually promise not to use the information (if he did, why the question?), and (3) has no ethical duty not to use the information. His secret use of the information, then, could hardly “feign fidelity to the source of information” and thus could not be fraudulent.
Now, would I advise the doctor to make this trade? No way. The SEC has a long history of seeking expansion of the insider trading laws and might, if aware of all the facts, come after the doctor with some concocted theory of liability. Under current doctrine, though, the trade would not seem fraudulent.