uty. Under the third approach, the insider was subject to a fiduciary duty to disclose material information when buying stock from shareholders. By the late 1930s, the "special circumstances" rule had been adopted in the majority of states and the fiduciary duty rule had been adopted in a significant minority of the states. These rules, however, were limited in their application. They were applied only in situations where the insider engaged in face-to-face transactions with existing shareholders. In exchange transactions, no duty of disclosure existed in most jurisdictions.
The passage of the Securities Exchange Act in 1934 superseded these state laws, although it did not preempt them. It was not the efforts of Congress which resulted in this supersession, but the rulemaking process of the Securities and Exchange Commission under Section 10b of the Act and the federal judicial interpretation of these rules and provisions. Section 10b and Rule 10b-5 were not cited as regulating insider trading until 1961. In that year, SEC Chairman Cary decided that the rule prohibited insider trading. In that decision, the Commission held that insider trading constituted fraud or deceit in connection with the purchase or sale of securities, in violation of Rule 10b-5C.
This ruling amounted to a prediction of how the federal courts were going to interpret Rule 10b-5 with regard to insider trading. In 1968, the Second Circuit Court of Appeals held that
anyone in possession of material inside information must either disclose it to the investing public, or, if he is disabled from disclosing it in order to protect a corporate confidence, or he chooses not to do so, must abstain from trading in or recommending the securities concerned while such inside information remains undisclosed.
The decision in this case established a precedent for other federal courts to follow. The cases succeeding it constructed a federal common law ...