Securities & Exchange Commission v. Dorozhko
2009 U.S. App. LEXIS 16057, 2009 WL 2169201, 574 F.3d 42 (2009)
Rule of Law:
Section 10(b) of the Securities Exchange Act of 1934 prohibits "deceptive devices," and this term encompasses affirmative misrepresentations used to fraudulently obtain material nonpublic information for securities trading. Such conduct can be deemed deceptive even in the absence of a breach of a fiduciary duty to the source of the information or the trading parties.
Facts:
- In early October 2007, Oleksandr Dorozhko, a Ukrainian national, opened an online trading account with Interactive Brokers LLC and deposited $42,500.
- IMS Health, Inc. (IMS) announced it would release its third-quarter earnings after the close of the New York City securities markets on October 17, 2007, having hired Thomson Financial, Inc. (Thomson) to manage the online release of its reports from a secure server.
- Beginning at 8:06 a.m. on October 17, and continuing several times, an anonymous computer hacker attempted to gain access to the IMS earnings report by hacking into Thomson’s secure server.
- At 2:15 p.m. on October 17, minutes after Thomson received the IMS data, the hacker successfully located and downloaded the IMS data from the secure server.
- Beginning at 2:52 p.m., Dorozhko purchased $41,670.90 worth of IMS “put” options, representing approximately 90% of all purchases of “put” options for IMS stock for the prior six weeks.
- At 4:33 p.m., IMS announced earnings per share that were 28% below 'Street' expectations.
- On October 18, at market open, IMS’s stock price sank approximately 28% almost immediately, and within six minutes, Dorozhko sold all his IMS options, realizing a net profit of $286,456.59.
- Interactive Brokers noticed the irregular trading activity and referred the matter to the SEC, which alleged Dorozhko was the hacker.
Procedural Posture:
- The Securities and Exchange Commission (SEC) initiated a civil enforcement lawsuit against Oleksandr Dorozhko.
- The SEC sought and received a temporary restraining order from the United States District Court for the Southern District of New York (Naomi Reice Buchwald, Judge) freezing the proceeds of the 'put' option transactions in Dorozhko’s brokerage account.
- The District Court held a preliminary injunction hearing on November 28, 2007, hearing testimony and considering affidavits.
- On January 8, 2008, the District Court denied the SEC’s request for a preliminary injunction, ruling that computer hacking was not 'deceptive' under Section 10(b) without an accompanying breach of a fiduciary duty.
- The SEC (Plaintiff-Appellant) appealed the District Court’s order to the United States Court of Appeals for the Second Circuit.
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Issue:
Does an alleged scheme of computer hacking, which involves affirmative misrepresentations to gain unauthorized access to material nonpublic information used for securities trading, constitute a 'deceptive device or contrivance' under Section 10(b) of the Securities Exchange Act of 1934, despite the absence of a fiduciary duty owed by the hacker to the source of the information?
Opinions:
Majority - José A. Cabranes, Circuit Judge
Yes, computer hacking that involves affirmative misrepresentations to fraudulently obtain material nonpublic information used for securities trading can constitute a 'deceptive device' under Section 10(b) of the Securities Exchange Act of 1934, without requiring a breach of a fiduciary duty. The Court distinguished its holding from the Supreme Court's decisions in Chiarella, O'Hagan, and Zandford, noting that those cases primarily addressed fraud based on nondisclosure, where a duty to speak arising from a fiduciary relationship was essential. The Second Circuit clarified that while a breach of fiduciary duty is sufficient for fraud via nondisclosure, it is not a necessary element for all forms of deception under Section 10(b). The court emphasized that Section 10(b) also covers affirmative misrepresentations, where a general 'duty not to mislead' exists in commercial dealings. The ordinary meaning of 'deceptive' encompasses conduct involving cheating or trading in falsehoods, such as misrepresenting one's identity to gain unauthorized access to information. Given the Supreme Court's instruction to construe Section 10(b) flexibly to effectuate its remedial purposes, the court found no precedent precluding the SEC's theory that hacking involving misrepresentations could be 'deceptive'. The court thus vacated the district court's order and remanded the case for a determination of whether the specific computer hacking in this case involved a fraudulent misrepresentation that was 'deceptive' within the ordinary meaning of Section 10(b).
Analysis:
This case significantly clarifies the scope of 'deceptive device' under Section 10(b) of the Securities Exchange Act of 1934, distinguishing between fraud by nondisclosure (which typically requires a fiduciary duty) and fraud by affirmative misrepresentation (which does not). The ruling broadens the applicability of federal securities laws to encompass modern forms of information theft, like certain types of computer hacking, that involve active trickery to gain an unfair trading advantage. This allows the SEC to pursue enforcement actions against 'outsiders' who may not have traditional fiduciary duties but employ sophisticated technological means to defraud the market, enhancing investor protection in an increasingly digital landscape.
