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Help Wanted: Seductive Women to Get Insider Info

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Someone has placed a job placement notice on a controversial online classified ads site seeking "beautiful, sophisticated ladies" to seduce businessmen in hopes of "extracting key pieces of information."

Julia La Roche of Business Insider says that the ad was sent to her by a trader who noticed it on BackPage.com, a website that has been accused of aiding sex trafficking of underage girls and prostitution. Goldman Sachs was once an indirect investor in Backpage.com, which was a subsidiary of Village Voice Media—in which Goldman held a 16 percent stake.

The advertisement claims to be placed by "a group that specializes in extracting" information from executives "by seducing them with beautiful ladies."

The legality of this is questionable. But the case against this as a form of insider trading is not as airtight as you might expect.

Let's start with the basics. The legal prohibition against insider trading is not embodied in any specific statute. Instead, the ban is based on an interpretation of a broader ban on fraud under SEC Rule 10b-5. The classical theory of insider trading is that insiders violate Rule 10b-5 by using material, nonpublic information for personal gain in breach of their fiduciary duties.

People who don't have fiduciary duties can engage in prohibited insider trading if they receive an illegal tip from someone who does have a duty. The basic idea here is to prevent insiders from getting around the law by giving insider information to co-conspirators not directly tied to the company in question.

Tipper-tippee liability has two important elements. First, there must be a disclosure of material, nonpublic information by someone with a fiduciary duty. Second, the person doing the disclosing—the tipper—must expect a personal benefit as a result of the disclosure. In effect, this means that accidental disclosures do not give rise to insider trading liability for either the tipper or the tippee.

So if we start with the assumption that the "key pieces of information" sought by this group are, in fact, material nonpublic data about publicly traded companies, the question of whether this is insider information will turn on how and why it was disclosed. If a business executive unwittingly disclosed this information to a seductress, the seductress would likely not be under any legal obligation not to disclose this information to someone who planned to trade on it.

The key word phrase here is "unwittingly disclosed." If the executive in question disclosed the information in order to impress the seductress, hoping to gain the personal benefit of her companionship, that probably is enough to give rise to insider trading liability.

There's no bright line here. In a case called SEC v. Maxwell, the court held that a disclosure of material, nonpublic information about a merger by an executive to his barber did not give rise to tippee liability, even though the two had a 15-year business relationship (if that's what one calls one's dealings with a barber) and the barber's trading in the company stock reaped a substantial gain. While in another case, SEC v. Sargent, the court held that a leak to a dentist by a patient with whom he was socially friendly did violate the ban. It appears the social relationship tipped the scale, if you'll excuse the accidental pun.

For these purposes, the shorter the seduction, the less chance of liability attaching itself. A long affair might give rise to liability under the Sargent theory. A short seduction might not.

What would also work against the "beautiful, sophisticated ladies" in this case is that they have set out to seduce the businessmen in order to obtain the information. This means that, at least on their part, the disclosure is not accidental. They intend for it to occur. It's easy to see a court believing that the businessman in question would understand this intention and so any disclosure would be in search of a personal benefit.

It might be possible to get around this, however, by training the seductresses well enough so that the businessmen never realize the purpose of the seduction. Obtaining information from a businessman who was unaware that the attentions of a young woman were based on his access to and looseness with insider information, wouldn't give rise to tippee liability. So the company employing the women might retain its freedom to trade on the information.

The trickiest part, of course, is that the disclosure must be voluntary but completely unmotivated. That's a fine line to tread. If a seductress just goes through the executive's Blackberry or briefcase, that will count as stealing the information and give rise to insider trading liability—as well as other possible legal violations—under the misappropriation theory of insider trading.

The misappropriation theory was developed by courts and the SEC to close a loophole that would otherwise allow people who don't owe a fiduciary duty to the company that issued the stock to trade with material, nonpublic information. For instance, an employee of a newspaper that is about to break a big story about a public company wouldn't be liable for insider trading under the classical theory. But he can be liable under the misappropriation theory for breaching a duty to the newspaper.

Under this theory, a trader can be held liable for breaching a fiduciary duty to the source of information—even when the source is not the company itself.

UCLA law professor Stephen Bainbridge explains the technicalities:

As eventually refined, the misappropriation theory imposed liability on persons who (1) misappropriated material nonpublic information (2) thereby breaching a fiduciary duty or a duty arising out of a similar relationship of trust and confidence and (3) used that information in securities transaction, regardless of whether they owed any duties to the shareholders of the company in whose stock they traded.

The SEC has created a rule about duties of trust or confidence called Rule 10b5-2 It gives "a non-exclusive definition of circumstances in which a person has a duty of trust or confidence for purposes of the 'misappropriation' theory." Three circumstances are listed.

The three circumstances are:

1. Whenever a person agrees to maintain information in confidence;

2. Whenever the person communicating the material nonpublic information and the person to whom it is communicated have a history, pattern, or practice of sharing confidences, such that the recipient of the information knows or reasonably should know that the person communicating the material nonpublic information expects that the recipient will maintain its confidentiality; or

3. Whenever a person receives or obtains material nonpublic information from his or her spouse, parent, child, or sibling; provided, however, that the person receiving or obtaining the information may demonstrate that no duty of trust or confidence existed with respect to the information, by establishing that he or she neither knew nor reasonably should have known that the person who was the source of the information expected that the person would keep the information confidential, because of the parties' history, pattern, or practice of sharing and maintaining confidences, and because there was no agreement or understanding to maintain the confidentiality of the information.

The relevant question for the seductresses is whether or not the seduction created a fiduciary duty arising out of a relationship "of trust and confidence." Most likely, the process of seduction would entail creating exactly that kind of thing—trust and confidence. So that's a step toward the line of illegality for the seductresses.

But even this might be enough because the precise contours of this trust and confidence matter. The seductress is not a spouse, for example. And the relationship must be a fiduciary relationship—or a relationship similar to a fiduciary relationship. This means that one person must trust the other person to serve his interests. So the question here would be: Does what goes on between a businessman and a beautiful woman who seduces him amount to a fiduciary relationship?

In general, the answer to that is: probably not. But certain behavior could give rise to that kind of relationship. For instance, if the seductress gave reassurances along the lines of: "Don't worry, baby, I won't tell anyone. You can trust me." This could create a relationship giving rise to a duty required for misappropriation to apply. Again, however, a seductress could be coached to avoid making any statements that would give rise to this kind of liability.

The SEC would probably argue that the general habit of sharing one's secrets with a lover gives rise to a duty of trust or confidence under number 2 above. That is, the SEC would argue that there was "a history, pattern, or practice of sharing confidences, such that the recipient of the information knows or reasonably should know that the person communicating the material nonpublic information expects that the recipient will maintain its confidentiality." But this would likely only work if the relationship between the seductress and the businessman were carried on for long-enough that a "history, pattern, or practice" developed.

The legality of trading on information intentionally extracted from a seduced businessman, in other words, would largely turn on his motivation for revealing the information and the length of the relationship. If he thinks he is just blowing off steam about a business deal to a one-night stand who was going to sleep with him anyway, this entire scheme wouldn't violate any insider trading rules.

Although, of course, the executive could find himself in hot water with his employer for telling a woman he hardly knows the secrets of the company.

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