Opinion ID: 2501
Heading Depth: 1
Heading Rank: 3

Heading: Deceptive Device

Text: 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, 947 F.2d 551, 575 (2d Cir. 1991) (Winter, J., concurring in part and dissenting in part) (stating that, after Chiarella, silence cannot constitute a fraud absent a duty to speak owed to those who are injured). Justice Blackmun, joined by Justice Marshall, dissented. In their view, stealing information from an employer was fraudulent within the meaning of Section 10(b) because the statute was designed as a catchall provision to protect investors from unknown risks. Id. at 246, 100 S.Ct. 1108 (Blackmun, J., dissenting). According to Justice Blackmun, the majority had confine[d] the meaning of fraud by imposition of a requirement of a `special relationship' akin to fiduciary duty before the statute gives rise to a duty to disclose or to abstain from trading upon material, nonpublic information. Id. [4] In O'Hagan, the defendant was an attorney who traded in securities based on material, nonpublic information regarding his firm's clients. As in Chiarella, the government alleged that the defendant had committed fraud through silence because the defendant had a duty to disclose to the source of the information (his client) that he would trade on the information. The Supreme Court agreed, noting that [d]eception through nondisclosure is central to the theory of liability for which the Government seeks recognition. 521 U.S. at 654, 117 S.Ct. 2199. [I]f the fiduciary discloses to the source that he plans to trade on the nonpublic information, there is no `deceptive device' and thus no § 10(b) violationalthough the fiduciary-turned-trader may remain liable under state law for breach of a duty of loyalty. Id. at 655, 117 S.Ct. 2199. In Zandford, the defendant was a securities broker who traded under a client's account and transferred the proceeds to his own account. The Fourth Circuit held that the defendant's fraud was not in connection with the purchase or sale of a security because it was mere theft that happened to involve securities, rather than true securities fraud. The Supreme Court reversed in a unanimous opinion, observing that Section 10(b) should be construed not technically and restrictively, but flexibly to effectuate its remedial purposes. 535 U.S. at 819, 122 S.Ct. 1899. Although the Court warned that not every common-law fraud that happens to involve securities [is] a violation of § 10(b), id. at 820, 122 S.Ct. 1899, the defendant's scheme was a single plan to deceive, rather than a series of independent frauds, and was therefore in connection with the purchase or sale of a security, id. at 825, 122 S.Ct. 1899. In a final footnote, the Court offered the following observation: [I]f the broker told his client he was stealing the client's assets, that breach of fiduciary duty might be in connection with a sale of securities, but it would not involve a deceptive device or fraud. 535 U.S. at 825 n. 4, 122 S.Ct. 1899. In the instant case, the District Court interpreted the Zandford footnote as an explicit[ ] acknowledg[ment] that Zandford would not be liable under § 10(b) if he had disclosed to Wood that he was planning to steal his money. Dorozhko, 606 F.Supp.2d at 338. The District Court concluded that in Chiarella, O'Hagan, and Zandford, the Supreme Court developed a requirement that any deceptive device requires a breach of a fiduciary duty. In applying that interpretation to the instant case, the District Court ruled that [a]lthough [defendant] may have broken the law, he is not liable in a civil action under § 10(b) because he owed no fiduciary or similar duty either to the source of his information or to those he transacted with in the market. Dorozhko, 606 F.Supp.2d at 324. [5] At least one of our sister circuits has made the same observation relying on the same precedent. See Regents of the Univ. of Cal. v. Credit Suisse First Boston (USA), Inc., 482 F.3d 372, 389 (5th Cir.2007) (discussing Chiarella and O'Hagan, and stating that the [Supreme] Court . . . has established that a device, such as a scheme, is not `deceptive' unless it involves breach of some duty of candid disclosure). In our view, none of the Supreme Court opinions relied upon by the District Courtmuch less the sum of all three opinions  establishes a fiduciary-duty requirement as an element of every violation of Section 10(b). In Chiarella, O'Hagan, and Zandford, the theory of fraud was silence or nondisclosure, not an affirmative misrepresentation. The Supreme Court held that remaining silent was actionable only where there was a duty to speak, arising from a fiduciary relationship. In Chiarella, the Supreme Court held that there was no deception in an employee's silence because he did not have duty to speak. See 445 U.S. at 226, 100 S.Ct. 1108 (This case concerns the legal effect of the petitioner's silence.  (emphasis added)); see also id. at 227-28, 100 S.Ct. 1108 (At common law, misrepresentation made for the purpose of inducing reliance upon the false statement is fraudulent. But one who fails to disclose material information prior to the consummation of a transaction commits fraud only when he is under a duty to do so. (emphasis added)). In O'Hagan, an attorney who traded on client secrets had a fiduciary duty to inform his firm that he was trading on the basis of the confidential information. See 521 U.S. at 653, 117 S.Ct. 2199 (noting that a breach of a duty of trust and confidence. . . to his law firm was conduct that satisfies § 10(b)'s requirement that chargeable conduct involve a `deceptive device or contrivance'); see also id. at 654, 117 S.Ct. 2199 (Deception through nondisclosure is central to the theory of liability for which the Government seeks recognition. (emphasis added)). Even in Zandford, which dealt principally with the statutory requirement that a deceptive device be used in connection with the purchase or sale of a security, the defendant's fraud consisted of not telling his brokerage clientto whom he owed a fiduciary dutythat he was stealing assets from the account. See 535 U.S. at 822, 122 S.Ct. 1899 ([Defendant's brokerage clients] were injured as investors through [defendant's] deceptions, which deprived them of any compensation for the sale of their valuable securities.); see also id. at 823, 122 S.Ct. 1899 ([A]ny distinction between omissions and misrepresentations is illusory in the context of a broker who has a fiduciary duty to her clients.). Chiarella, O'Hagan, and Zandford all stand for the proposition that nondisclosure in breach of a fiduciary duty satisfies § 10(b)'s requirement . . . [of] a `deceptive device or contrivance,' O'Hagan, 521 U.S. at 653, 117 S.Ct. 2199. However, what is sufficient is not always what is necessary, and none of the Supreme Court opinions considered by the District Court require a fiduciary relationship as an element of an actionable securities claim under Section 10(b). While Chiarella, O'Hagan, and Zandford all dealt with fraud qua silence, an affirmative misrepresentation is a distinct species of fraud. Even if a person does not have a fiduciary duty to disclose or abstain from trading, there is nonetheless an affirmative obligation in commercial dealings not to mislead. See, e.g., Basic Inc. v. Levinson, 485 U.S. 224, 240 n. 18, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988) (distinguishing situations where insiders have traded in abrogation of their duty to disclose or abstain, from affirmative misrepresentations by those under no duty to disclose (but under the ever-present duty not to mislead)). In this case, the SEC has not alleged that defendant fraudulently remained silent in the face of a duty to disclose or abstain from trading. Rather, the SEC argues that defendant affirmatively misrepresented himself in order to gain access to material, nonpublic information, which he then used to trade. We are aware of no precedent of the Supreme Court or our Court that forecloses or prohibits the SEC's straightforward theory of fraud. [6] Absent a controlling precedent that deceptive has a more limited meaning than its ordinary meaning, we see no reason to complicate the enforcement of Section 10(b) by divining new requirements. In reaching this conclusion, we are mindful of the Supreme Court's oft-repeated instruction that Section 10(b) should be construed not technically and restrictively, but flexibly to effectuate its remedial purposes. Zandford, 535 U.S. at 819, 122 S.Ct. 1899 (internal quotation marks omitted). [7] Accordingly, we adopt the SEC's proposed interpretation of Chiarella and its progeny: misrepresentations are fraudulent, but . . . silence is fraudulent only if there is a duty to disclose. Appellant's Br. 44. Having denied the SEC's application for a preliminary injunction freezing defendant's trading account on the basis of a perceived fiduciary duty requirement stemming from the Chiarella line of insider trading cases, the District Court did not decide whether the ordinary meaning of deceptive covers the computer hacking in this caseor, indeed, whether the computer hacking in this case involved any misrepresentation at all. Defendant invites us to remand both questions so that the District Court may decide in the first instance. In its ordinary meaning, deceptive covers a wide spectrum of conduct involving cheating or trading in falsehoods. See Webster's International Dictionary 679 (2d ed.1934) (defining deceptive as tending to deceive, and defining deceive as [t]o cause to believe the false, or to disbelieve the true or [t]o impose upon; to deal treacherously with; cheat). Cf. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 199 n. 20, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976) (consulting the 1934 edition of Webster's International Dictionary to define other relevant terms in Section 10(b)); In re Parmalat Sec. Litig., 376 F.Supp.2d 472, 502 n. 152 (S.D.N.Y.2005) (consulting the 1934 edition of Webster's International Dictionary to define deceptive). In light of this ordinary meaning, it is not at all surprising that Rule 10b-5 equates deceit with fraud. See 17 C.F.R. § 240.10b-5 (prohibiting any untrue statement of a material fact . . . or . . . any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security (emphases added)). Indeed, we have previously observed that the conduct prohibited by Section 10(b) and Rule 10b-5 irreducibly entails some act that gives the victim a false impression. United States v. Finnerty, 533 F.3d 143, 148 (2d Cir. 2008). The District Courtsummarizing the SEC's allegationsdescribed the computer hacking in this case as employ[ing] electronic means to trick, circumvent, or bypass computer security in order to gain unauthorized access to computer systems, networks, and information . . . and to steal such data. Dorozhko, 606 F.Supp.2d at 329. On appeal, the SEC adds a further gloss, arguing that, in general, [computer h]ackers either (1) `engage in false identification and masquerade as another user[']. . . or (2) `exploit a weakness in [an electronic] code within a program to cause the program to malfunction in a way that grants the user greater privileges.' Appellant's Br. 22-23 (quoting Orin S. Kerr, Cybercrime Scope: Interpreting Access and Authorization in Computer Misuse Statutes, 78 N.Y.U. L.Rev. 1596, 1645 (2003)). In our view, misrepresenting one's identity in order to gain access to information that is otherwise off limits, and then stealing that information is plainly deceptive within the ordinary meaning of the word. It is unclear, however, that exploiting a weakness in an electronic code to gain unauthorized access is deceptive, rather than being mere theft. Accordingly, depending on how the hacker gained access, it seems to us entirely possible that computer hacking could be, by definition, a deceptive device or contrivance that is prohibited by Section 10(b) and Rule 10b-5. However, we are hesitant to move from this general principle to a particular application without the benefit of the District Court's views as to whether the computer hacking in this caseas opposed to computer hacking in generalwas deceptive. Our caution is counseled by the considerable and careful efforts the District Court has already devoted to this case, including hearing live testimony from witnesses at a preliminary injunction hearing that covered, among other topics, how Thomson's secure servers were infiltrated. See, e.g., J.A. 848 Tr. of Preliminary Injunction Hearing at 40-41, Dorozkho, 606 F.Supp.2d. 321 (No. 07 civ 9606). Having established that the SEC need not demonstrate a breach of fiduciary duty, we now remand to the District Court to consider, in the first instance, whether the computer hacking in this case involved a fraudulent misrepresentation that was deceptive within the ordinary meaning of Section 10(b). The District Court may, in its informed discretion, enter a new order on the basis of the existing record or reopen the preliminary injunction hearing to consider such additional testimony regarding the nature of the hacking in this particular case as it deems appropriate in the circumstances.