Thursday, November 19, 2009

Hackers Liable for Insider Trading?

I posed a question in an earlier post as to the liability of computer hackers for insider trading when they break into a company's computer systems, obtain material non-public information, and then trade on that information. There are a number of problems with that legal theory, as there is no fiduciary relationship between the hacker and the company. While the courts have eviscerated the legal underpinnings of 10(b)5 over the years, there is no support for the concept that a thief, a complete corporate outsider, has any liability under 10(b)5. His theft is a theft, it is not a fraud, and should not give rise to a securities fraud case, and certainly not an insider trading case.

A commenter pointed out a recent Second Circuit decision, in SEC vs. Dorozhko, where the Court did find that such liability existed. The decision, handed down this summer, finds liability under 10(b)5 for a computer hacker. The decision is not surprising, since the Second Circuit has been at the forefront of the expansion of insider trading liability since the 1980s, going back to the first civil use of the misappropriation theory in SEC vs. Materia, a case that I handled with one of my former partners in 1987.

The Dorozhko decision has been widely criticized for expanding 10(b)5 beyond all reasonable limits. Profession Bainbridge posted an outstanding analysis of the decision at his corporate law blog, titled "The Second Circuit’s Egregious Decision in SEC v. Dorozhko" which is well worth reading.

None of this is an argument that the hackers should not be punished. Many will agree that the criminal penalties for breaking into a computer system are more severe than the penalties for insider trading. After all, prison time is certainly worse than a financial penalty; even if that penalty is three times the profits of the trading.
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