What is Misappropriation Theory

Misappropriation theory postulates that a person who uses insider information in trading securities has committed securities fraud against the information source. In the United States, a person who is guilty according to the misappropriation theory will likely be convicted of insider trading.

BREAKING DOWN Misappropriation Theory

Misappropriation theory differs from the classical theory of insider trading. Under the classical theory, a person who is not an insider but who learns of material non-public information and uses that to trade, is not guilty of insider trading. The classical theory requires that the person accused of insider trading be an actual insider — an officer or employee of the company whose securities he/she is buying or selling. Under this theory, only the corporate insider owes a fiduciary duty to the corporation and its shareholders not to engage in buying or selling the corporation's securities using material non-public information. The outsider who happens across some material non-public information does not owe that fiduciary duty and cannot be guilty of insider trading.

Under misappropriation theory, however, the outsider who happens across some material non-public information of a corporation may not use that information to trade because he/she owes a fiduciary duty to the source of the information.

The misappropriation theory gained prominence in the Supreme Court's conviction of James H. O'Hagan. O'Hagan was an attorney who acted on insider information regarding a takeover bid for Pillsbury. The United States versus O'Hagan was a watershed case for the theory.

Misappropriation theory is intended to protect securities markets from outsiders who have access to confidential corporate information but who do not owe a fiduciary duty to the corporation or its shareholders.