(Article from Securities Law Alert, September/October 2020)
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On September 22, 2020, the Second Circuit affirmed the insider trading conviction of a principal investigator in a clinical trial. United States v. Kosinski, 2020 WL 5637600 (2d Cir. 2020) (Korman, J.). The Second Circuit found the defendant had a duty to refrain from trading on the basis of material nonpublic information both because he was a “temporary insider” and because he had a “fiduciary-like relationship” with the company.
Principal Investigators in Clinical Trials Are “Temporary Insiders”
The Second Circuit emphasized that “a qualifying relationship” for insider trading purposes “does not require one to be a traditional corporate insider.” Rather, in Dirks v. SEC, 463 U.S. 646 (1983), the Court made it clear that a duty to refrain from trading in company stock arises when third parties “have entered into a special confidential relationship in the conduct of the business of the enterprise and are given access to information solely for corporate purposes.” Kosinski, 2020 WL 5637600 (quoting Dirks, 463 U.S. 646). The Second Circuit noted that it has “described such individuals as ‘temporary insiders.’” Kosinski, 2020 WL 5637600 (quoting United States v. Chestman, 947 F.2d 551 (2d Cir. 1991) (en banc)).
The Second Circuit determined that the defendant’s “role as a principal investigator . . . fit[s] squarely within Dirk’s recognition of ‘temporary insiders’ who play fiduciary-like roles.” The court reasoned that the defendant “was entrusted with [the company’s] information solely because of his duty to ensure the integrity and accuracy of the phase three clinical trial, as well as the health of his patients.” The court also found it significant that the defendant explicitly agreed to maintain the confidentiality of the information the company provided and to disclose holdings of company stock in excess of $50,000.
Principal Investigators Have a Fiduciary-Like Relationship With the Company
The Second Circuit further held that the defendant’s “relationship with [the company] was fiduciary in nature because it was a relationship based on trust and confidence,” memorialized in a confidentiality and stock disclosure agreement. The court found that the defendant’s “trading vitiate[d] the principal investigator’s critical function, by fixing his attention on his own monetary gain and depriving the company of the independent assessment required for FDA approval.” The court explained that when “a principal investigator’s financial interest becomes aligned with the outcome of the study—he has an incentive to lie about or conceal patients’ results in order to influence the study’s outcome, and ultimately his wallet.” The court concluded that “[a]llowing principal investigators to trade on the nonpublic inside information entrusted to them in the course of a study would . . . undermine that study’s integrity.”
Chestman Factors Are Not the Exclusive Standard for a Fiduciary Relationship
In Chestman, 947 F. 2d 551, the Second Circuit stated that “[a]t the heart of the fiduciary relationship lies reliance, and de facto control and dominance.” The Kosinski court clarified that Chestman’s “three-factor standard . . . does not state the exclusive test of fiduciary status, nor the proof necessary to sustain a conviction under the misappropriation theory” of insider trading. The Kosinski court explained that “Chestman itself set out two other tests . . . one of which is the traditional test that one acts as a fiduciary when the business which he transacts . . . is not his own or for his own benefit, but for the benefit of another person, as to whom he stands in a relation implying and necessitating great confidence and trust on the one part and a high degree of good faith on the other part.” The Kosinski court found that “while the evidence here was indeed sufficient to find that [the defendant] owed [the company] a fiduciary duty based on reliance, control, and dominance, that conclusion does not signal that only such factors can establish a fiduciary duty for purposes of determining insider-trading liability.”