John Carney has a provocative post about insider trading (pun intended):
Someone has placed a job placement notice on a controversial online classified ads site seeking "beautiful, sophisticated ladies" to seduce businessmen in hopes of "extracting key pieces of information."
Carney goes on to explore the legality of the business under the securities laws:
Tipper-tippee liability has two important elements. First, there must be a disclosure of material, nonpublic information by someone with a fiduciary duty. Second, the person doing the disclosing—the tipper—must expect a personal benefit as a result of the disclosure. In effect, this means that accidental disclosures do not give rise to insider trading liability for either the tipper or the tippee.
Quite correct.
After a detailed review of the relevant law, Carney concludes from his extended analysis that:
The legality of trading on information intentionally extracted from a seduced businessman, in other words, would largely turn on his motivation for revealing the information and the length of the relationship. If he thinks he is just blowing off steam about a business deal to a one-night stand who was going to sleep with him anyway, this entire scheme wouldn't violate any insider trading rules.
What do we think? First, the law is quite clear than an exlicit quid pro quo in which an executive swapped inside information for sex would constitute an illegal tip. Second, "pillow talk" in which information is inadvertently disclosed does not (subject to Carney's correct anlysis of the potential application of Rule 10b5-2).
But, third, there is a tricky precedent out there that Carney does not discuss; namely, SEC v. Dorozhko, 574 F.3d 42 (2d Cir. 2009), which dealt with a question left open in the U.S. Supreme Court U.S. v. O’Hagan decision--i.e., the liability of persons who steal inside information but have no fiduciary duty to either the source of the information or the issuer of the securities in which the thief trades.
I've got a backgrounder on the case here, in which I explain that:
In Dorozhko, the SEC alleged that a computer hacker broke into a health information company’s computer system and used the stolen information to essentially sell the stock short. The Second Circuit tried to finesse the rules discussed below by treating the case as one involving a misrepresentation rather than insider trading: “we recognize that the SEC’s claim against defendant—a corporate outsider who owed no fiduciary duties to the source of the information—is not based on either of the two generally accepted theories of insider trading.” The problem is that the case makes no sense other than as an insider trading case.
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 that light, consider Carney's argument that:
What would also work against the "beautiful, sophisticated ladies" in this case is that they have set out to seduce the businessmen in order to obtain the information. This means that, at least on their part, the disclosure is not accidental. They intend for it to occur. It's easy to see a court believing that the businessman in question would understand this intention and so any disclosure would be in search of a personal benefit.
It might be possible to get around this, however, by training the seductresses well enough so that the businessmen never realize the purpose of the seduction. Obtaining information from a businessman who was unaware that the attentions of a young woman were based on his access to and looseness with insider information, wouldn't give rise to tippee liability. So the company employing the women might retain its freedom to trade on the information.
I think Dorozhko works against Carney here. Theft by seduction likely would be viewed as analogous to theft via hacking.
Anyway, it's an interesting thought experiment. In these politically corret times, however, I don't recommend that law professors use it in class or on an exam. Some hyper-sensitive student doubtless would go running to the dean to complain about your lack of sensitivity to something or other.
