A 'high-tech lock pick' is upheld in Dorozhko insider trading case

A 'high-tech lock pick' is upheld in Dorozhko insider trading case
A 'high-tech lock pick' is upheld in Dorozhko insider trading case 

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 
lock pick."

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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