Securities and Exchange Commission Historical Society

Fair To All People: The SEC and the Regulation of Insider Trading

Pre-Securities Act Common Law Enforcement

Majority Rule – Minority Rule

For much of its early history, the SEC had limited involvement in the direct regulation of insider trading. Corporate law was primarily a state creation and the duty to regulate trading in securities remained largely a state responsibility. State courts developed different common law rules regulating stock trades by corporate insiders. Most state courts adopted the "majority rule," which rejected an affirmative duty by corporate officers and directors to disclose special information they may have acquired in the course of their corporate responsibilities. Based on actual fraud theory, the majority rule prevented only actual misrepresentation or concealment of facts material to the purchase or sale of stock.

There was no fraud liability for "mere silence." In other words, "a knowledgeable party could buy from or sell to an ignorant party unless there is a duty to disclose the nonpublic fact."(3) While it was not always clear when the duty to disclose arose, the clearest duty to disclose was that which arose between a fiduciary and a beneficiary. In common law fraud, while corporate directors had a fiduciary duty to the corporation, they had no such duty to a stockholder.

A few states adopted a "minority rule", which created a duty to disclose material information acquired by the corporate officer to shareholders before trading with them. This rule, which developed more or less concurrently with the majority rule, relied on the sense that a defendant insider had behaved immorally or unfairly.

State courts adopted the minority rule because they found a fiduciary relationship between officers and shareholders was made manifest by the officer's access to corporate information. States which adopted the minority rule criticized the majority rule as old and outdated, "leaving shareholders to the mercy of managers."(4) The courts argued that the majority rule effectively gave "approval to a course of dealing that will permit those occupying a trust relation to be unmindful of the trust, betray the confidence reposed, and profit by such betrayal."(5)

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(3) Dalley, Horse Trading, 1296.

(4) Oliver v. Oliver, 45 S.E. 232 (Georgia, 1903)

(5) Stewart v Harris, 77 P. 277 (Kansas, 1904)

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