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.

FBI Says Hackers Targeting Law Firms

According to the NYT, hackers are increasingly targeting law firms and public relations companies with a sophisticated e-mail scheme that breaks into their computer networks to steal sensitive data, often linked to large corporate clients doing business overseas. This might be an interesting test of our insider trading laws.

Hacker steals material, non-public information from law firm, trades. Is he liable for insidert trading violations? More>>>

Technorati Tags: insider trading

New AIG Chief Threatens to Quit Over Pay

It's tough working for the government, with politicans making business decisions.

Unhappy over constraints imposed by U.S. government overseers, AIG Chief Executive Robert Benmosche told the company's board last week that he is considering stepping down, according to the Wall Street Journal. Benmosche is said to be unhappy over a recent compensation review by Kenneth Feinberg, the Treasury bailout program's special master for compensation. More>>>

Bear Stearns Hedge Fund Managers Not Guilty

n a stunning defeat for the Justice Department, a federal jury in Brooklyn, N.Y., found two former Bear Stearns hedge fund managers not guilty of fraud charges Tuesday, only a day after jurors received the case.

According to The New York Times, the jury found that Matthew Tannin and Ralph Cioffi did not lie to investors in painting a rosy picture of the health of two funds backed by subprime mortgages which later collapsed and cost investors $1.6 billion.

The jury also acquitted Cioffi on an additional charge of insider trading, as prosecutors had accused the former portfolio manager of moving $2 million he had invested in one of his failing funds to a less risky fund while telling investors he was adding to his position. More>>>

Former SEC Attorney Pleads Guilty in Dreier Case

A lawyer pleaded guilty Monday to impersonating representatives of both a hedge fund and a pension fund in order to assist disgraced ex-attorney Marc S. Dreier in selling a phony promissory note.

The surprise plea and the lawyer's agreement to cooperate with prosecutors raised the possibility there might be more arrests in the investigation of Dreier, the former sole equity partner of 250-lawyer Dreier LLP who is serving a 20-year sentence for peddling hundreds of millions of dollars in bogus notes to investors. More>>>

Rep. Frank Vows to Limit Expansion of FINRA Power

Barney Frank, chairman of the House Financial Services Committee, said he will defeat a controversial measure that would expand the Financial Industry Regulatory Authority's power over financial advisers. Investment advisory groups, as well as consumer advocates and state regulators, praised Frank's promise. More>>>

Congress to Give FINRA Authority over RIAs

According to InvestmentNews.com, there has been an amendment to the Investor Protection Act which gives FINRA authority over the advisory activity of any broker-dealer that it regulates.

The bill would affect anyone who is dually registered as an investment adviser and a broker, and would greatly expand FINRA's authority over the financial markets.

On one level the proposal makes sense. In recent years we have seen the distinctions between brokers and advisers blurr, and in the retail area, there often is no substantive difference between the two. At least not to the investor, who often does not know, nor does he care, whether his financial adviser is a stock broker or an investment adviser.

The most notorious example is Madoff, who, although presenting himself and his firm as a brokerage firm, was actually acting, or purporting to act, as an investment adviser. In that example, a distinction without a difference, and giving FINRA authority over the RIA side of the BDs business might have made a difference.

That is not to say that FINRA should have authority over all RIAs. There are thousands of investment advisers who are not brokers and who do not work for broker-dealers. Those adviser are now regulated by the states, or by the SEC, depending on how much money they manage.


The committee is scheduled to vote on the Investor Protection Act Nov. 4. According to InvestmentNews.com, it is likely to approve the bill. More>>>

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Getting Arbitration Facts Wrong

Litigation 2009 - Home Court Disadvantage at American Lawyer attempted to put together an article about the large cases being won before FINRA arbitration panels, but in doing so demonstrates a marked bias in the media against arbitration. Or, perhaps just an abject failure to fact check.

The article correctly points out that there have been some significant cases won in arbitration, multimillion dollar verdicts in favor of investors, but in the course of reaching that conclusion makes a number of flagrantly wrong, and significantly misleading, statements regarding FINRA arbitration.

For example

FINRA's reputation for siding with the securities industry was long lamented and well-known to even casual investors

Long lamented? Perhaps. At least one party to every litigation proceeding is unhappy with the outcome. Sometimes even both sides. But "well-known?" Hardly. Ask any experienced securities attorney, and the key word is "experienced" and they will agree that while their might be a panel here and there over the thousands of arbitration panels that have decided cases, there is no institutional bias in favor of the industry, and certainly no reputation for siding with the industry. There are no statistics, studies or reports which demonstrate any bias in securities arbitrations for the industry. Customers settlement rates and “win” rates are well over 75%, and “win” rates are consistently higher in arbitration than in comparable court proceedings.


Attorneys for investors point out that from 2003 to 2008, customers won damages in only 27 percent of cases filed

I don't know which attorneys for investors they spoke to, but the statement is simply wrong. Incredibly wrong. According to FINRA’s statistics, over 50% of the cases that are concluded are resolved by a settlement. Of the remaining 50% that go to a hearing, customers won 44% of the time from 2003 to to 2008. That puts a customer win rate at something on the magnitude of 70%, assuming of course that a customer did not settle a case without getting some compensation.


FINRA and its predecessors have long been the financial services industry's preferred venue for claims.

FINRA requires, by regulation, that all members of the financial services industry arbitrate all claims against them at FINRA arbitration. It is not the firms preferring the venue, it is the venue forcing firms to use its forum; by force of law.

FINRA arbitrations don't provide for discovery, which could also be a challenge for investors' lawyers, due to the complexity of the products at issue

Incredibly wrong again. FINRA arbitration procedures have virtually unlimited document discovery. FINRA arbitration proceedings do not have depositions, which at a cost of a couple of thousand dollars a day, are a significant cost for an investor in a court litigation. Further, the parties have the ability to request depositions, and whatever other discovery devises they need. And, if justified, the arbitration panel can order depositions.

…nonpublic arbitrator--the slot that, according to investors' lawyers, usually favors securities firms.

In 25 years of representing parties in securities arbitration I never heard an investors' attorney make this claim. "Usually favors securities firms" is a libel of the thousands of nonpublic arbitrators, and there are no studies or reports to support such an outrageous claim. In fact, there are reports that show that there is no difference in a customer award rates between public and nonpublic arbitrators.


FINRA arbitration certainly isn't perfect, but repeating misstatements without fact checking, in a legal publication, does nothing to correct the problems that do exist, and actually hampers the efforts of those who are attempting to make the process better for all participants.