## Facts

- Douglas Aircraft Company privately informed Merrill Lynch, a prospective managing underwriter for a Douglas debenture offering, that Douglas’s earnings had fallen sharply and projections were being materially reduced.
- Merrill Lynch conveyed the substance of this adverse earnings information to certain institutional clients, including investment advisers, mutual funds, and investment partnerships.
- The respondents understood the information came from Douglas and that it had been received in connection with Merrill Lynch’s underwriting role.
- Between June 21 and June 23, 1966, before any public announcement, respondents sold most or all of their Douglas holdings and placed substantial short sales.
- After public disclosure, Douglas stock declined significantly.
- The SEC initiated an administrative proceeding alleging antifraud violations; an administrative law judge found violations and ordered censure.
- The Commission conducted limited review and issued an opinion affirming the findings and sanctions.

## Issues

1. Whether the earnings shortfall and reduced forecast information was material and nonpublic when transmitted and traded upon.
2. Whether non-insider recipients who knew or had reason to know the information was selectively disclosed and not public had a duty to abstain from trading.
3. Whether the timing and pattern of respondents’ transactions permitted an inference that the information was a factor in their decisions to sell and short sell.
4. Whether respondents’ fiduciary obligations to clients could justify trading on improperly obtained material nonpublic information.

## Decision

- The Commission held the earnings information was material and nonpublic at the time of respondents’ trades.
- The Commission found respondents violated the antifraud provisions (including Exchange Act § 10(b) and Rule 10b-5 concepts) by selling and short-selling while in possession of the information, with knowledge or reason to know it was nonpublic and improperly obtained through selective disclosure.
- The Commission concluded the immediacy and magnitude of trading supported an inference that the information was a factor in the trading decisions.
- The Commission affirmed censure of each respondent as an appropriate sanction.

## Legal Principles

- Nonpublic information is material if it is significant enough that it could reasonably be expected to affect investors’ judgment about a security and, if generally known, to affect the market price.
- Materiality analysis may consider the information’s specificity, its divergence from prior public information, and its reliability based on the source and circumstances of receipt.
- Rapid trading consistent with the direction indicated by the information is probative of materiality and supports an inference of use.
- A recipient who trades on material nonpublic information may violate the antifraud provisions where the recipient knew or had reason to know the information was nonpublic and improperly obtained through selective revelation.
- An investment adviser’s fiduciary duty to clients does not authorize trading on material nonpublic information; client-serving objectives must be pursued within the limits of the antifraud provisions.

## Conclusion

The SEC concluded that institutional market participants who knowingly trade on selectively disclosed, material nonpublic earnings information engage in deceptive conduct under the antifraud provisions, and it affirmed censure as a regulatory sanction for such tippee trading.


In re Investors Management Co., Inc., 44 S.E.C. 633 (1971)