The Second Circuit’s en banc decision in SEC v. Texas Gulf Sulphur Corp.[1] (“TGS”) is approaching its 50th anniversary, and it’s still well-known for several important holdings. Perhaps the most celebrated (or condemned) accepted the SEC’s argument that corporate insiders have a duty to “abstain or disclose” from trading while in possession of material nonpublic information.  The opinion makes a bold claim that the law in play (Rule 10b-5’s antifraud prohibition) “is based in policy on the justifiable expectation of the securities marketplace that all investors trading on impersonal exchanges have relatively equal access to material information.”[2] From that comes a command of considerable breadth: “[A]nyone in possession of material inside information must either disclose it to the investing public, or, if he is disabled from disclosing it in order to protect a corporate confidence, or he chooses not to do so, must abstain from trading in or recommending the securities concerned while such inside information remains undisclosed.”[3]

There is a standard story among legal scholars about this expression of naked egalitarianism—that it was either a triumphant or seditious idea (depending on perspective) that had its moment in the sun in the 1970s, but which the Supreme Court put to death 12 years later in Chiarella v. United States.  In a forthcoming article (part of a symposium on TGS to appear in the SMU Law Review, available here), I look back, as a matter of legal archeology if nothing else, on the pathway from TGS to Chiarella and beyond, and show that the real story is much more complicated.

As is well known, the SEC had in its Cady Roberts decision developed its own (somewhat primitive) version of the duty to abstain or disclose seven years earlier, a duty that was status rather than possession based. In the early post-TGS cases, the commission seemed much more interested in building out its vision than pursuing egalitarianism per se.  It was bolstered in this by a counter-narrative at the time that TGS didn’t really mean what it said,[4] which got further traction in the mid-1970s as the American Law Institute—with the support of the securities law establishment—sought to recodify the regulatory infrastructure, including insider trading.  The Federal Securities Code rejected the egalitarian approach as not an apt reflection of then-current law.  There was also political pushback, naturally enough, especially given the threat of draconian private damage liability and the recognition that loose language in TGS could be put to use in upsetting many lucrative “market information” practices on Wall Street.  Suffice it to say that by 1976, the SEC—in a well-publicized speech by Commissioner Philip Loomis, who had argued TGS in the Second Circuit—explicitly disavowed market egalitarianism as neither good law nor good policy.

There are more intriguing archeological details, but this is enough to make it curious that the Supreme Court in Chiarella resurrected egalitarianism in order to kill it again.  (The Second Circuit decision on review had also disavowed mere possession as a source of duty). My impression is that Wall Street used it as a boogeyman, and that lawyers in the Solicitor General’s Office (perhaps still under the spell of Frank Easterbrook) were content to let it be so used because they wanted to reorient insider trading law away from anything like TGS or Cady Roberts.  Thus we got the strange—and entirely inaccurate—claim from Justice Lewis Powell that “we cannot affirm petitioner’s conviction without recognizing a general duty between all participants in market transactions to forego actions based on material, nonpublic information.”[5]  His narrower fiduciary duty test, supposedly needed to counter rampant egalitarianism, was a choice, not a necessity.

So does any of this matter today?  Perhaps not, though some ghostly remnants of the old egalitarianism exist to this day—the SEC’s Regulation FD, state-law litigation like the New York State Attorney General’s “Insider Trading 2.0,”[6] and statutory reform proposals popping up from time to time in Congress that harken back to the old imagined idealism.[7]

Chiarella was a stopping point for something else, though not necessarily realized at the time.  This is the second pathway from TGS to Chiarella that I explore, dealing with the corporation’s affirmative duty to disclose corporate secrets.  TGS had a footnote suggesting that there was such a duty unless some business justification existed for remaining silent, which was coherent with the spirit of equal access because prompt disclosure is a principal mechanism by which market prices could stay close to fundamental value for the benefit of all traders.  And over the next decade courts experimented with what that might mean.  But that effectively came to a halt when lower courts realized that Chiarella was about the duty to disclose, not just insider trading, and that the rule that a pre-existing duty was necessary precluded fraud-on-the-market cases based on corporate silence, too.  The law of corporate disclosure promptly went adrift, making concealment cases turn on silly distinctions so that true silence about even the most material facts is rewarded with legal absolution, while saying a bit too much about the subject triggers large potential liability.  The horribly muddled law is with us still, as demonstrated by the recent frenzy of debate about the Leidos case,[8] which almost brought the Supreme Court back, for the first time, to confront Chiarella’s collateral damage.

To summarize: In Chiarella, the Supreme Court truncated two doctrinal journeys for which TGS might be seen as a starting point—one on the scope of the insider trading prohibition, the other on the public corporation’s affirmative duty to disclose.  For each of these, my reaction is the same: While what TGS said or implied was overbroad and probably needed substantial refinement, that work soon began and was in progress over the 12 years between the two decisions.  Securities law would have been better off, I suspect, had both journeys been permitted to continue without the scuttling.

ENDNOTES

[1]  401 F.2d 833 (2d Cir. 1968)(en banc).

[2]  Id. at 848.

[3]   Id.

[4]  This was the assessment of Professor (and future SEC Chair) David Ruder, in his influential commentary on the case.

[5] Chiarella, 445 U.S. at 233.  The Court did not cite TGS explicitly for this, but did refer to the lower appellate court opinion that, in turn, borrowed the language from TGS.

[6]  These are efforts to attack institutional practices that promote unequal access to material information.  On Insider Trading 2.0 and Reg FD, see Donald C. Langevoort, Selling Hope, Selling Risk: Corporations, Wall Street and the Dilemmas of Investor Protection 82-84 (2016).

[7] E.g., S. 702, 114^th Cong., 1^st Sess., March 11, 2015 (introduced by Senators Reed and Menendez).

[8] The Supreme Court granted certiorari on whether SEC line items create a duty to disclose in Indiana Pub. Ret. System v. SAIC Inc., 818 F.3d 85 (2d Cir. 2016), cert. granted sub nom. Leidos Inc. v. Indiana Pub. Ret. System, 137 S.Ct. 1395 (2017).  The parties settled the case, and so the writ was withdrawn after briefing was essentially complete.

This post comes to us from Donald C. Langevoort, the Thomas Aquinas Reynolds Professor of Law at Georgetown University Law Center. It is based on his forthcoming article, “From Texas Gulf Sulphur to Chiarella: A Tale of Two Duties,” available here.