Dirks v. SEC

Tippee liability and the conditions under which insider-trading duties attach.

Dirks, a securities analyst, received information from a former Equity Funding employee alleging massive fraud. He investigated, discussed the allegations with clients and investors, and some clients sold before the fraud became public. The SEC censured Dirks for aiding and abetting insider trading.

The Court rejected liability for Dirks and tied tippee liability to breach of fiduciary duty by the insider and the tippee's knowledge of that breach.

Justice Powell reasoned that not all trading on nonpublic information violates the securities laws. A tippee's duty is derivative of the insider's breach, and breach depends on whether the insider personally benefits from disclosure. Because the information was disclosed to expose fraud rather than for personal gain, Dirks did not inherit a prohibited duty.

1. How does the rule affect information production, investor reliance, and enforcement costs?
2. What are the likely error costs for lawful market activity and for undetected misconduct?