West v. Prudential Securities, Inc.

282 F.3d 935 (7th Cir. 2002)

Facts:

  • Stockbroker worked for D.
  • Broker informed certain other investors that Jefferson Savings Bankcorp would soon be acquired for a high price.  Broker informed P of this as well.
  • As a result, P invested in Jefferson.
  • P and others who acted on the insider information were guilty of violating insider trading laws.
  • However, P argued that other investors who were uninvolved with the insider information were harmed, because the share price was artificially inflated if they purchased the stock following the purchases of the inside traders.
  • D argued that this information was never public, thus the theory of reliance (from fraud on the market theory) could not come into play in the instant case.

Issue:

  • Can insider information – which was never available publicly – be used in a fraud on the market, theory of reliance claim?

Holding:

  • No, the notion that those outside the insider trading scheme were harmed cannot be based on fraud on the market theory.  The statements made were never public, thus they could never have been relied on by outsiders.
    • Because the statements were never public, they never had the opportunity to have a significant impact on trading volume.
  • The evidence did show the stock was higher around the time the insiders purchased their shares, but the court finds no causal link between the few individuals who purchased shares and the overall stock price increase.
  • The fraud on the market theory was designed to protect investors from false or misleading (or omitted) statements made in the public sphere.  That theory cannot be reapplied to non-public insider trading information.  Non-public statements cannot have the same impact as public statements.  By their very nature, the statements don’t reach the public and can’t induce investor behavior.

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