Eddie Krule Take-Home Final Exam ekrule@kellogg.northwestern.

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Why didn't Chiarella go to jail? Did the Supreme Court get that one right? Over the course of this class I have learned that there is often tension between what the court deems illegal, what is immoral and what the legislature would like to make illegal. That conflict is often the point on which the outcome of the case balances upon, of which Chiarella v. United States is a perfect example. The two main components of federal security law are section 10(b) and 10b-5, which outline actions that constitute insider trading. However, as evident in Chiarella v. United States, it is in the interpretation and implementation of 10b and 10b-5 that may lead to seemingly conflicting judgments in court decisions. After the SEC began an investigation of his trading activities, Chiarella was indicted and convicted for violating 10(b) and 10b-5. It was determined that Chiarella failed to inform sellers that he knew of a forthcoming takeover bid that would make their shares more valuable. Chiarellas conviction was affirmed by the Court of Appeals. However, when the case was brought before the Supreme Court it was determined that Chiarellas conduct did not constitute a violation of 10(b), and his conviction was reversed. However, understanding the rational behind this decision will help us determine whether or not the Supreme Court was correct in its decision. The rational behind the Supreme Courts decision, let by Justice Powell and the Corporate Fiduciary Theory, was that while Chiarellas actions in connection with the purchase of the shares may operate as a fraud under 10(b), all liability is premised upon a fiduciary duty. Here, Chiarella had no fiduciary duty to any party involved in the transaction, as he was not a corporate insider. Additionally, Powell admits that while Chiarella may have owed a duty not to use information as a matter or law, in this case the jury was told that any person who comes into possession of material nonpublic information and trades on it is liable but in actuality there needs to be quasi fiduciary duty, a duty to disclose under 10(b) does not arise from the mere possession of material nonpublic information. This technicality in the original instructions to the jury and understanding of fiduciary duty led to Chiarellas release.

However, two Supreme Court justices, Burger and Blackmun, dissented Justice Powells rational and use of the corporate fiduciary theory. Justice Blackmun raised Equal Playing Field Theory, in that any use material nonpublic information results in an unfair advantage and should be punishable. This parity of information theory was rejected in the Chiarella case, as it was determined that liability is premised upon a fiduciary duty that did not exist in this situation. However, it is Justice Burgers Misappropriation theory that raises the biggest issue with the Supreme Courts decision. Under the misappropriation theory, one has an obligation not to misuse information entrusted to you. This take on insider trading expands the traditional view of what constitutes guilt (i.e. corporate insider with a fiduciary duty). Instead of looking only at corporate insiders who trade on material nonpublic information, the theory extends to those who use the knowledge to profit in any corporation. Justice Burgers dissent made sense, especially in light of United States v. OHagen in which the Supreme Court endorsed the misappropriation theory, establishing liability for corporate outsiders who misappropriate, and then trade on, inside information in violation of a fiduciary duty owed to the information source. The question remains, if the Supreme Court upheld the misappropriation theory as a valid basis on which to impose insider-trading liability in United States v. OHagen why did it not apply in Chiarella v. United States? I believe that there are two answers as to why the Supreme Court was correct in its judgment and both relate to the nature of the legal system in the United States. First, with regards to United States v. OHagen, the case took place 17 years after Chiarella v. United States and in that time a new section, 14e-3, was enacted. 14e-3 attempts to prevent fraudulent behavior related to tender offers based on material nonpublic information no matter who you are and whether or not you have the conventional fiduciary duty. This update in federal security laws is a result of the organic nature of the United States legal system, which evolves over time to address new events and revise laws that may have been unclear or incomplete. So based on the current understanding of duty in Chiarella v. United States, the Supreme Court held that duty arises from a

relationship between the parties in a transaction. Chiarella worked for the printer, not the targets whose stock he bought, and therefore owed no fiduciary duty to the targets shareholders. Defines as such, Chiarella did not commit insider trading. The second answer has to do with the courts responsibility to operate within the confines of the legal system in order to ensure a fair and just process. In the case of Chiarella v. United States, upon review of the Second Courts decision, Justice Powell found that the misappropriation theory had not been presented to the jury, and thus the Supreme Court must not consider the theory in the case. Had it been properly presented to the jury, perhaps the conviction would have been affirmed based on the misappropriation theory. However, the Supreme Court must operate within the confines of the legal system and as such could not affirm the original conviction on the basis of a theory not originally presented to the jury. As such, it is my opinion that based on information available to the Supreme Court in both federal security laws as defined in time of Chiarella v. United States and proceedings of the trial in the Second Court, the Supreme Court was correct in its decision.

Assume that you are tasked with rethinking the course on corporations/business law you just finished. How would you change it, and why? When I signed up for the Business Law course, I didnt realize that the class was offered through the law school. I was under the impression that the class was taught through the business school and tailored for Kellogg students. When I attended the first class, I was a little taken aback by the fact that the course was part of the law school curriculum and I would be taking the class with northwestern law school students, many of whom were second years. I had no experience with law school, the way the classes were taught and analyzing legal cases and wasnt sure how much I would benefit from the class. However, many, if not all, of my concerns were alleviated after the first class and my understanding and appreciation for the law grew over the subsequent 10 weeks. There are however, several changes I would suggest as a Kellogg student to make the class more approachable for business students as well as more expansive for those students who may not take additional business law classes in the future. My first recommendation would be to have additional reading materials, perhaps only for Kellogg students, that were a little more approachable then the traditional legal cases. For Kellogg student, especially those with no legal background, these cases can be difficult to understand with the legalese and presentation. Additionally, they are significantly different in format and delivery then the traditional business cases Kellogg students are used too. If it were possible to have reading materials more accessible to Kellogg students that reinforced the concepts discussed in each class, I believe it would help those students understand more and therefore be able to contribute more to the class. My second suggestion would be to invite guest speakers from the business side to give their perspective on various legal topics discussed in the class. This would be as much for the law school students as it would be for those at Kellogg. As we discussed in class, and one of the questions on the midterm, I think this would be a valuable exercise in understanding the other sides frame of reference and how they make decisions within the confines of their understanding of the law. Understanding how managers view the role of the law as well as the lawyers they work with can be a very valuable resource.

My third recommendation addresses the scope of the material covered in class. I understand that this is an introductory business law class and its not possible to cover all aspects of the subject in one course, but there were a variety of topics I had hoped to cover in class. Some topics I would have liked to see covered included bankruptcy and reorganization, antitrust, tax, intellectual property, non-hostile merger and E-commerce laws just to name a few. I believe that many of these are very topical issues and of much interest to Kellogg and law school students and even high-level discussion and analysis would be beneficial. I understand that law students will likely take courses covering these topics later, but for Kellogg students this will likely be their only touch point with these topic frames in a legal structure. Additionally, I know that Kellogg students would appreciate more insight into methods of dispute resolution such as litigation and arbitration, something they will likely have to deal with in the future, as well as becoming more familiar with common legal forms and papers. It may be difficult to fit all these topics in a 10-week course, but I believe that if the course could be reformatted to include these topics, Kellogg students would come out more prepared to understand the legal framework. This leads me to my fourth and final recommendation, one that probably wont make me to popular with my classmates. Since there is a lot of material to cover and limited time, I would suggest that the course has additional assignments, both group and individual, to supplement the readings and lectures. This will enable the students to cover some of the added material I suggested, and any questions can be addresses in class at a more targeted pace. Additionally, groups should consist of both Kellogg and law students in order to promote cross-discipline learning. Similar to what was done in class with drafting the shareholder agreements, these exercises accomplish much in the way of seeing the law in practice something I found particularly interesting. While I enjoyed the course immensely and it did much to expand my understanding of the law, as well as some business concepts, I think that these suggestions would accomplish much in making the course more accessible for Kellogg students.