Back in December 2008, in this article entitled, “Steal, Hack, Create, Bribe, Seduce… Just a Few of the Ways to Get Your Hands on Inside Information,” I wrote that
Over the years we’ve seen numerous efforts and plots to gain insider information through means ranging from theft and bribery to computer hacking and even seduction. Others have gone so far as to “self-generate” market-moving information (which sometimes has actually been true, but usually is false). Let’s take a walk through some of these schemes, and offer a quick verdict on their degrees of success:
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People who hack into BusinessWire or corporate computer systems to gain access to material, non-public information before it is announced. Verdict: Hung jury. There is uncertainty right now as to whether “mere thieves” of information commit insider trading or violate the securities laws when they steal, trade on, and profit from that information. In two recent cases (SEC v. Lohmus Haavel & Viisemann and SEC v. Blue Bottle Ltd.), defendants sued by the SEC for variations of this conduct settled or had default judgments against them without a court ruling on the legality of their conduct. In a subsequent contested case (SEC v. Dorozhko), however, the court issued an opinion that stealing or hacking and then trading on that data does not violate Rule 10b-5 of the Securities Exchange Act.
After yesterday’s Second Circuit opinion in SEC v. Dorozhko, however, we need to consider taking hacking out of the “hung jury” category. Yesterday, the Second Circuit reversed the lower court that had ruled that computer hacking was not “deceptive” within the meaning of Section 10(b) as defined by the Supreme Court. According to the District Court, the Second Circuit wrote,
“a breach of a fiduciary duty of disclosure is a required element of any ‘deceptive’ device under § 10b.” Dorozhko, 606 F. Supp. 2d at 330. The District Court reasoned that since defendant was a corporate outsider with no special relationship to IMS or Thomson, he owed no fiduciary duty to either.
The Second Circuit held, however, that Supreme Court cases such as
Chiarella, O’Hagan, and Zandford all stand for the proposition that nondisclosure in breach of a fiduciary duty “satisfies § 10(b)’s requirement . . . [of] a ‘deceptive device or contrivance,'” O’Hagan, 521 U.S. at 653. However, what is sufficient is not always what is necessary, and none of the Supreme Court opinions considered by the District Court require a fiduciary relationship as an element of an actionable securities claim under Section 10(b). While Chiarella, O’Hagan, and Zandford all dealt with fraud qua silence, an affirmative misrepresentation is a distinct species of fraud. Even if a person does not have a fiduciary duty to “disclose or abstain from trading,” there is nonetheless an affirmative obligation in commercial dealings not to mislead.
The Court concluded that “[a]ccordingly, we adopt the SEC’s proposed interpretation of Chiarella and its progeny: “misrepresentations are fraudulent, but . . . silence is fraudulent only if there is a duty to disclose.”
In my online discussion today with law professor Peter Henning about insider trading, he stated that he was surprised by the Second Circuit’s decision:
