Theft and Insider Trading

Posted by:  Paul Rose

In Friday's New York Times, Floyd Norris discusses a case in which a hacker obtained material, non-public information and made $296,456 in trading profits.  Do insider trading laws require him to forfeit the gains?   

This situation exists because of a strange anomaly in American securities laws. A person who legally obtains insider information — as a corporate official or an investment banker, for example — will almost certainly break the securities law if he or she trades on the basis of that information before it is made public.

But it is far less clear that someone who illegally gets their hands on such information will have violated the securities laws by trading on it. The securities law used to bring insider trading charges — Section 10(b) of the 1934 Securities Exchange Act — talks of “a deceptive device or contrivance,” and it is not clear that there is any deception involved in simple theft.

It goes back to fiduciary duty.  Reminiscent of Chiarella, in this case District Court Judge Buchwald ruled that because there was no duty owed to the victims of the theft, there is no deception on which a 10b-5 claim could be based.  The SEC argued to no avail that the required element of deception was satisfied by hacking into the system, which was only for use by authorized persons.  Norris quotes Donald Langevoort, who has written extensively on insider trading (including a treatise) as asking: “Did he commit fraud? Yes.  Was it for the purpose of obtaining a trading advantage? Yes. Why should that not reach the level of the statute?”   From a policy perspective, I agree with Professor Langevoort.  However, the fiduciary duty requirement will likely continue to prevent such a result under U.S. law--as Norris notes, an act of Congress would seem necessary to ensure such activty falls under the insider trading laws. 

(hat tip: Justin Kilgore)