By Floyd Norris
International Herald Tribune
February 14, 2008
NEW YORK: There is not much doubt that Oleksandr Dorozhko used inside
information when he made a killing trading stock options last autumn.
Nor is there a dispute that he gained the information illegally. His
lawyer, arguing before an appeals court this week, spoke of "a high-tech
But that does not mean that Dorozhko, a Ukrainian resident, will have to
forfeit the $296,456 he earned in one day of trading, beginning just
hours before the company in question announced disappointing earnings.
The Securities and Exchange Commission blocked him from collecting the
profits from his brokerage account, but a federal court judge has
ordered the SEC to let him have the cash.
The hearing this week, before the U.S. Court of Appeals in New York, was
on the SEC's request for an emergency order to keep the money frozen. If
the commission loses, the case against Dorozhko will effectively be
over. Even if the SEC later wins the case, the chances of collecting a
judgment in Ukraine would be slim at best.
This situation exists because of a strange anomaly in U.S. 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.
"Dorozhko's alleged 'stealing and trading' or 'hacking and trading' does
not amount to a violation" of securities laws, a U.S. District Court
judge, Naomi Reice Buchwald, ruled last month.
Although he may have broken laws by stealing the information, the judge
concluded, "Dorozhko did not breach any fiduciary or similar duty in
connection with the purchase or sale of a security." She ordered the SEC
to let him have his profits.
She refused to dismiss the case, saying the SEC could try to prove that
he had gotten a tip from an insider, but there does not appear to be any
evidence of that. Instead, the evidence indicates that on Oct. 17, 2007,
someone hacked into a computer system that had information on an
earnings announcement to be made by IMS Health a few hours later.
Soon after the breach of computer security, Dorozhko invested $41,671 in
put options that would expire worthless three days later unless IMS
shares plunged before that. The next morning the share price did plunge,
and Dorozhko made his money by selling the put options.
The SEC argues that deception was involved in hacking into the computer
system, which was designed to allow access only to authorized persons.
That view drew scorn from Charles Ross, Dorozhko's lawyer, at the
appellate court hearing Wednesday. "They want you to believe there is a
deception of a computer," he said. "All there is is a high-tech lock
That argument seemed to draw some sympathy from one of the three judges
hearing the appeal.
"You deceived a machine," said Judge Sonia Sotomayor, invoking the image
of "Big Brother" from George Orwell's novel, 1984. "We are treating a
machine as a person."
Judge Buchwald appreciated the absurdity of the situation, and expressed
disappointment that the Justice Department had not brought criminal
charges for computer hacking. The government has offered no explanation
for that, but it is possible the department saw no likelihood of ever
being able to arrest Dorozhko and did not think the case worth the
The judge also noted that case law could have developed differently,
harking back to Justice Harry Blackmun's dissent to the Supreme Court's
1980 decision that reversed the insider trading conviction of Vincent
Chiarella, a financial printer who learned of takeover targets from his
work and traded on the information.
The court, Blackmun wrote then, was moving in a direction "that catches
relatively little of the misbehavior that all too often makes investment
in securities a needlessly risky business for the uninitiated investor."
Donald Langevoort, a law professor at Georgetown University and author
of a treatise on insider trading law, said in an interview that he
thought that the SEC should prevail in the case.
"Did he commit fraud? Yes," Langevoort said. "Was it for the purpose of
obtaining a trading advantage? Yes. Why should that not reach the level
of the statute?"
The appeals court will decide soon if the asset freeze stands, but a
ruling on whether the judge correctly interpreted the law, if it comes
at all, is many months away. She would first have to dismiss the case.
In the meantime, Congress could clear all this up with a simple
amendment to the law.
"The European Union revised their insider trading laws to make it clear
that any gaining of inside information by criminal activity would be a
violation of insider trading laws," Langevoort said.
If it is illegal to trade on information acquired legally, why should it
be legal to trade on information that was acquired illegally?
Copyright 2008 The International Herald Tribune
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