Misappropriation Theory Explained: Insider Trading Laws & Key Examples (2025)
Explore the Misappropriation Theory in insider trading law, its significance in securities fraud cases, and real-world examples illustrating its application.
Adam Hayes, Ph.D., CFA, brings over 15 years of Wall Street experience as a derivatives trader and financial writer. With deep expertise in economics and behavioral finance, Adam holds a master’s degree in economics from The New School for Social Research and a Ph.D. in sociology from the University of Wisconsin-Madison. He is a CFA charterholder and holds FINRA Series 7, 55, and 63 licenses. Currently, Adam researches and teaches economic sociology and finance at Hebrew University in Jerusalem.
What Is Misappropriation Theory?
Misappropriation theory is a legal doctrine that considers the use of insider information by someone outside a company to trade securities as securities fraud against the source of that information. In the United States, individuals found guilty under this theory can be prosecuted for insider trading.
Although U.S. securities laws do not explicitly ban insider trading, it is prohibited as a deceptive trading practice when it involves material, nonpublic information.
Key Takeaways
- Misappropriation theory prohibits trading based on confidential, nonpublic information obtained by outsiders.
- It forms the legal foundation for prosecuting insider trading violations.
- The theory aims to maintain fairness and efficiency in securities markets by protecting information integrity.
Understanding the Misappropriation Theory
Unlike the classical insider trading theory, which targets corporate insiders breaching their fiduciary duties to shareholders, misappropriation theory focuses on outsiders who misuse confidential information entrusted to them.
When an outsider receives sensitive, nonpublic information about a company and trades securities based on that knowledge, they violate the trust of the information source—typically a corporate insider—and commit misappropriation.
Real-World Examples of Misappropriation Theory
The landmark case United States v. O'Hagan brought misappropriation theory to prominence. James H. O'Hagan, an attorney, was convicted for trading securities based on insider information about a takeover bid for the Pillsbury Corporation.
Another notable case involved Carl Reiter, a real estate developer in the 1980s. After receiving a tip about an impending merger of Revco Drug Stores during a casual golf game, Reiter purchased stock and profited $2,625. Unaware of the illegality, Reiter was later charged under misappropriation theory along with others who used the nonpublic information. He was required to forfeit his profits and paid fines imposed by the Securities and Exchange Commission (SEC).
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