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Horwich: The Mosaic Theory of Materiality



Allan Horwich (Northwestern University – School of Law ; Schiff Hardin LLP) has posted “The Mosaic Theory of Materiality – Does the Illusion Have a Future? “, Northwestern Law & Econ Research Paper No. 14-05.

The abstract is as follows:

The mosaic theory of materiality provides that a corporate insider who discloses inconsequential information to an outsider who in turn uses that information to complete a material mosaic about the corporation does not violate Rule 10b-5 when trading based on that mosaic. The SEC and commentators support variants of the theory; the concept has never been directly applied in a reported case. Developing insider trading law tends to support the SEC’s qualification that Rule 10b-5 is implicated if the insider knows that the information that is inconsequential standing alone will complete the outsider-tippee’s material mosaic. Commentators who read enforcement actions taken by the SEC and judicial decisions as undermining or even rejecting the theory have misread those developments?the theory has vitality and the SEC has not backed off from its recognition of it.

In practice, however, any insider tempted to provide an outsider with what the insider thinks is immaterial nonpublic information runs a substantial risk that he will be charged with tipping and may have an uphill battle defending the charge. Similarly, the resourceful analyst or investor who seeks to obtain trifling scraps of information from an insider must take into account what the insider knows about what the interlocutor already knows about the company and thus whether any disclosure will be an unlawful tip. What in theory appears to afford a viable means to fend off a charge of unlawful insider trading may be illusory in application.


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