BNA Securities Regulation and Law Report:
The U.S. District Court for the Southern District of New York March 24 granted summary judgment to the Securities and Exchange Commission in the case involving Ukrainian computer hacker Oleksandr Dorozhko (SEC v. Dorozhko, S.D.N.Y., No. 07 Civ. 9606 (NRB), 3/24/10).
In the closely watched proceedings, the SEC had argued that hacking into computer systems to obtain confidential, internal information that is later used to trade securities violates 1934 Securities Exchange Act Section 10(b) and Rule 10b-5 even in the absence of a breach of fiduciary duty.
In July, the U.S. Court of Appeals for the Second Circuit agreed with the SEC, concluding that a computer hacker who trades on material nonpublic information can be held liable for insider trading even if the hacker did not violate any fiduciary duty in obtaining the information (41 SRLR 1410, 7/27/09). The appellate court remanded for the district court to determine “whether the computer hacking in this case involved a fraudulent misrepresentation that was ‘deceptive’ within the ordinary meaning of Section 10(b).”
In February, the SEC moved the district court for summary judgment. Dorozhko's counsel Charles A. Ross, of Charles A. Ross & Associates LLC, New York, did not oppose the motion, telling the court that his efforts to reach his client for instructions have been unsuccessful (42 SRLR 519, 3/22/10).
I continue to think the case was wrongly decided, for the reasons I explained in my essay RULING ON HACKERS AS INSIDE TRADERS: RIGHT IN THEORY, WRONG ON THE LAW:
An affirmative misappropriation can be actionable under Section 10(b) and Rule 10b-5 if it is *committed in connection with the purchase or sale of a security. In order to find that the hacker committed an affirmative misrepresentation, a court first must find a lie. Calling computer hacking a lie is a rather considerable stretch. At most, the hacker “lies” to a computer network, not a person. Hacking is theft; not fraud.
Even if hacking is fraudulent in the sense of an affirmative misrepresentation, it has to be in connection with a purchase or sale of a security to be insider trading. In SEC v. Zandford, 535 U.S. 813 (2002), the Supreme Court emphasized that “the statute must not be construed so broadly as to convert every common-law fraud that happens to involve securities into a violation of § 10(b).” That case, moreover, involved “a fraudulent scheme [by a stockbroker] in which he made sales of his customer’s securities for his own benefit.” The SEC had taken the position that such conduct violated 10b-5 since the 1940s. In contrast, the district court in Dorozhko “found it ‘noteworthy’ that in the over seventy years since the enactment of the Securities Exchange Act of 1934, ‘no federal court has ever held that those who steal material nonpublic information and then trade on it violate § 10(b),’ even though ‘traditional theft (e.g. breaking into an investment bank and stealing documents) is hardly a new phenomenon, and involves similar elements for purposes of our analysis here.’” Dorozhko, 606 F. Supp. 2d 321, 339 (SDNY 2008).
In sum, this case was an attempt by the SEC to end run the fiduciary duty requirement applicable to nondisclosure cases. It is an end run around the basics of insider trading law, and the Second Circuit aided and abetted it.
Even if hacking is fraudulent in the sense of an affirmative misrepresentation, it has to be in connection with a purchase or sale of a security to be insider trading. In SEC v. Zandford, 535 U.S. 813 (2002), the Supreme Court emphasized that “the statute must not be construed so broadly as to convert every common-law fraud that happens to involve securities into a violation of § 10(b).” That case, moreover, involved “a fraudulent scheme [by a stockbroker] in which he made sales of his customer’s securities for his own benefit.” The SEC had taken the position that such conduct violated 10b-5 since the 1940s. In contrast, the district court in Dorozhko “found it ‘noteworthy’ that in the over seventy years since the enactment of the Securities Exchange Act of 1934, ‘no federal court has ever held that those who steal material nonpublic information and then trade on it violate § 10(b),’ even though ‘traditional theft (e.g. breaking into an investment bank and stealing documents) is hardly a new phenomenon, and involves similar elements for purposes of our analysis here.’” Dorozhko, 606 F. Supp. 2d 321, 339 (SDNY 2008).
In sum, this case was an attempt by the SEC to end run the fiduciary duty requirement applicable to nondisclosure cases. It is an end run around the basics of insider trading law, and the Second Circuit aided and abetted it.
