S.E.C. v. Dorozhko

574 F.3d 42

SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellant, v. Oleksandr DOROZHKO, Defendant-Appellee.

Docket No. 08-0201-cv.

United States Court of Appeals, Second Circuit.

Argued: April 3, 2009.

Decided: July 22, 2009.

Mark Pennington, Assistant General Counsel (Brian G. Cartwright, General Counsel, Andrew N. Vollmer, Deputy General Counsel, Jacob H. Stillman, Solicitor, and David Lisitza, Attorney, on the brief), Washington, D.C.

Charles A. Ross (Christopher L. Padurano and Stephanie M. Carvlin, on the brief) Charles A. Ross & Assoc., LLC, New York, NY.

Before: CABRANES, HALL, Circuit Judges, and SULLIVAN, District Judge.^*

JOSÉ A. CABRANES, Circuit Judge:

We are asked to consider whether, in a civil enforcement lawsuit brought by the United States Securities and Exchange Commission ("SEC") under Section 10(b) of the Securities Exchange Act of 1934 ("Section 10(b)"), computer hacking may be "deceptive" where the hacker did not breach a fiduciary duty in fraudulently obtaining material, nonpublic information used in connection with the purchase or sale of securities. For the reasons stated herein, we answer the question in the affirmative.

BACKGROUND

In early October 2007, defendant Oleksandr Dorozhko, a Ukranian national and resident, opened an online trading account with Interactive Brokers LLC ("Interactive Brokers") and deposited $42,500 into that account. At about the same time, IMS Health, Inc. ("IMS") announced that it would release its third-quarter earnings during an analyst conference call scheduled for October 17, 2007 at 5 p.m.—that is, after the close of the securities markets in New York City. IMS had hired Thomson Financial, Inc. ("Thomson") to provide investor relations and web-hosting services, which included managing the online release of IMS's earnings reports.

Beginning at 8:06 a.m. on October 17, and continuing several times during the morning and early afternoon, an anonymous computer hacker attempted to gain access to the IMS earnings report by hacking into a secure server at Thomson prior to the report's official release. At 2:15 p.m.—minutes after Thomson actually received the IMS data—that hacker successfully located and downloaded the IMS data from Thomson's secure server.

Beginning at 2:52 p.m., defendant—who had not previously used his Interactive Brokers account to trade—purchased $41,670.90 worth of IMS "put" options that would expire on October 25 and 30, 2007.¹ These purchases represented approximately 90% of all purchases of "put" options for IMS stock for the six weeks prior to October 17. In purchasing these options, which the SEC describes as "extremely risky," defendant was betting that IMS's stock price would decline precipitously (within a two-day expiration period) and significantly (by greater than 20%). Appellant's Br. 2.

At 4:33 p.m.—slightly ahead of the analyst call—IMS announced that its earnings per share were 28% below "Street" expectations, i.e., the expectations of many Wall Street analysts. When the market opened the next morning, October 18, at 9:30 a.m., IMS's stock price sank approximately 28% almost immediately—from $29.56 to $21.20 per share. Within six minutes of the market opening, defendant had sold all of his IMS options, realizing a net profit of $286,456.59 overnight.

Interactive Brokers noticed the irregular trading activity and referred the matter to the SEC, which now alleges that defendant was the hacker. See SEC v. Dorozhko, 606 F.Supp.2d 321, 323 (S.D.N.Y.2008) (explaining that the SEC's theory rests on "two undisputed events: (1) the fact of the hack, and (2) the proximity to the hack of the trades by [defendant,] who was the only individual to trade heavily in IMS Health put options subsequent to the hack"). On October 29, 2007, the SEC sought and received from the United States District Court for the Southern District of New York (Naomi Reice Buchwald, Judge) a temporary restraining order freezing the proceeds of the "put" option transactions in defendant's brokerage account. The District Court held a preliminary injunction hearing on the matter on November 28, 2007, at which it heard testimony and considered various affidavits.

On January 8, 2008, in a thoughtful and careful opinion, the District Court denied the SEC's request for a preliminary injunction because the SEC had not shown a likelihood of success. Specifically, the District Court ruled that computer hacking was not "deceptive" within the meaning of Section 10(b) as defined by the Supreme Court. According to the District Court, "a breach of a fiduciary duty of disclosure is a required element of any `deceptive' device under § 10b." Dorozhko, 606 F.Supp.2d at 330. The District Court reasoned that since defendant was a corporate outsider with no special relationship to IMS or Thomson, he owed no fiduciary duty to either. Although computer hacking might be fraudulent and might violate a number of federal and state criminal statutes, the District Court concluded that this behavior did not violate Section 10(b) without an accompanying breach of a fiduciary duty.

This appeal followed. On appeal, the SEC maintains its theory that the fraud in this case consists of defendant's alleged computer hacking, which involves various misrepresentations. The SEC does not argue that defendant breached any fiduciary duties as part of his scheme. In this critical regard, 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. See United States v. Cusimano, 123 F.3d 83, 87 (2d Cir.1997) (distinguishing "the traditional theory of insider trading, under which a corporate insider trades in the securities of his own corporation on the basis of material, non-public information," from "the misappropriation theory, [under which] § 10(b) and Rule 10b-5 are violated whenever a person trades while in knowing possession of material, non-public information that has been gained in violation of a fiduciary duty to its source"). The SEC's claim is nonetheless based on a claim of fraud, and we turn our attention to whether this fraud is "deceptive" within the meaning of Section 10(b).

DISCUSSION

Standard of Review

We review the grant or denial of a preliminary injunction for abuse of discretion. E.g., Kickham Hanley P.C. v. Kodak Retirement Income Plan, 558 F.3d 204, 209 (2d Cir.2009) ("[A]buse of discretion . . . occurs when (1) its decision rests on an error of law or a clearly erroneous factual finding, or (2) its decision—though not necessarily the product of a legal error or a clearly erroneous factual finding—cannot be located within the range of permissible decisions." (internal citations, parentheticals, and quotation marks omitted)); Davis v. New York, 316 F.3d 93, 102 (2d Cir. 2002).

"Deceptive Device"

"Section 10(b) prohibits the use or employ, in connection with the purchase or sale of any security . . ., [of] any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe." 15 U.S.C. § 78j(b)² The instant case requires us to decide whether the "device" in this case— computer hacking—could be "deceptive."³

In construing the text of any federal statute, we first consider the precedents that bind us as an intermediate appellate court—namely, the holdings of the Supreme Court and those of prior panels of this Court, which provide definitive interpretations of otherwise ambiguous language. Insofar as those precedents fail to resolve an apparent ambiguity, we examine the text of the statute itself, interpreting provisions in light of their ordinary meaning and their contextual setting. See United States v. Magassouba, 544 F.3d 387, 404 (2d Cir.2008) ("In determining whether statutory language is ambiguous, we `reference . . . the language itself, the specific context in which that language is used, and the broader context of the statute as a whole.'" (quoting Robinson v. Shell Oil Co., 519 U.S. 337, 341, 117 S.Ct. 843, 136 L.Ed.2d 808 (1997))). Where the statutory language remains ambiguous, "we resort to canons of construction and, if the meaning still remains ambiguous, to legislative history." Magassouba, 544 F.3d at 404 (internal alterations and quotation marks omitted).

The District Court determined that the Supreme Court has interpreted the "deceptive" element of Section 10(b) to require a breach of a fiduciary duty. See Dorozhko, 606 F.Supp.2d at 338 ("[T]he Supreme Court has in a number of opinions carefully established that the essential component of a § 10(b) violation is a breach of a fiduciary duty to disclose or abstain that coincides with a securities transaction."). The District Court reached this conclusion by relying principally on three Supreme Court opinions: Chiarella v. United States, 445 U.S. 222, 100 S.Ct. 1108, 63 L.Ed.2d 348 (1980), United States v. O'Hagan, 521 U.S. 642, 117 S.Ct. 2199, 138 L.Ed.2d 724 (1997), and SEC v. Zandford, 535 U.S. 813, 122 S.Ct. 1899, 153 L.Ed.2d 1 (2002). We consider each of these cases in turn.

In Chiarella, the defendant was employed by a financial printer and used information passing through his office to trade securities offered by acquiring and target companies. In a criminal prosecution the government alleged that the defendant committed fraud by not disclosing to the market that he was trading on the basis of material, nonpublic information. The Supreme Court held that defendant's "silence," or nondisclosure, was not fraud because he was under no obligation to disclose his knowledge of inside information. "When an allegation of fraud is based upon nondisclosure, there can be no fraud absent a duty to speak. We hold that a duty to disclose under § 10(b) does not arise from the mere possession of nonpublic market information." 445 U.S. at 235, 100 S.Ct. 1108; see also United States v. Chestman,...