Tuesday, October 26, 2021

Cert. petition asks justices to clarify ‘deceptive’ trading by outsiders

By Mark S. Nelson, J.D.

A brief filed on behalf of Vitaly Korchevsky asks the Supreme Court to clarify the law of illegal securities trading with respect to Exchange Act Section 10(b) and Rule 10b-5 provisions addressing a “scheme or artifice to defraud” and “deceptive device or contrivance[s].” Korchevsky had been convicted for his alleged role in a hacking operation and for trading stocks based on information obtained from the hacking operation. In the district court, Korchevsky was convicted of, among other things, conspiracy to commit securities fraud and computer intrusions and securities fraud; the Second Circuit upheld Korchevsky’s several convictions (Korchevsky v. U.S., October 18, 2021).

Decision below—SQL injection and securities charges. The Second Circuit upheld the convictions of Vladislav Khalupsky and Korchevsky for accessing hacked corporate press releases and then trading the stocks of the companies whose press releases had been stolen. In reviewing the convictions, the court also concluded that: (1) the government's proof at trial did not constructively amend or prejudicially vary from the superseding indictment; (2) the district court did not abuse its discretion in its handling of a jury note presented to the court during deliberations regarding whether one of the defendants had received and traded on certain press releases; and (3) the district court's giving of a conscious avoidance jury instruction was not erroneous.

According to the government, an intermediary provided the conduit between two stock traders and two groups of Ukraine-based hackers who were able to circumvent security measures at three wire services that stored corporate press releases prior to publication. The hackers and the intermediary provided the traders with access to a server housing the purloined press releases, which contained information about pending corporate announcements that were potentially market-moving. When the initial phase of the alleged conspiracy fell apart, a different hacker continued to provide access to the stolen press releases and the conspiracy continued, albeit with slightly different arrangements.

In both instances, however, the traders shared the illicit profits from their trading with the intermediary. Khalupsky made a net profit of $3.1 million from the illegal trading, while Korchevsky made a net profit of $15 million, a 1,660 percent return on investment. On appeal, Khalupsky and Korchevsky challenged, among other things, the sufficiency of the evidence against them and their securities fraud convictions

The Second Circuit began its review of the securities counts brought under Exchange Act Section 10(b) by “dispatch[ing]” Korchevsky’s arguments regarding his lack of a fiduciary duty. Korchevsky had argued that there was no “scheme or artifice to defraud” because he owed no fiduciary duty to investors and that his deception did not target investors. For one, the court said that when a case involves trading by an outsider, rather than an insider, no fiduciary duty is required. Second, the court explained that deception need only track the requirement that there be deception “in connection with” the buying or selling of any security.

Next, the court addressed Korchevsky’s argument that the alleged computer hacking was not a “deceptive device or contrivance.” The court explained that the evidence showed how Korchevsky and others benefitted from a SQL injection attack to gain access to employee login information at the wire services, which them enabled the conspirators to access secured areas of the wire services’ computer systems. Although the court refrained from characterizing the legal status of the SQL injection, the court did further explain that the use of employee logins to move laterally through the wire services’ computer systems amounted to Korchevsky and others misrepresenting themselves as authorized users of those computer systems. As a result, the court concluded that Korchevsky had engaged in illegal behavior that fell within the plain meaning of “deception.”

Petition seeks clarity on fiduciary duty. Korchevsky's petition for certiorari asserted that the Second Circuit had misapplied the law in upholding Korchevsky's securities conviction. Specifically, Korchevsky argued, by analogy to the law of misappropriation-based insider trading, that the Second Circuit's reasoning could be read to apply broadly to almost any securities trading because the court did not adequately identify a specific fiduciary duty owed by Korchevsky.

Korchevsky further argued that the Second Circuit upheld his conviction on the theory that Korchevsky owed a general fiduciary duty to all market participants. According to Korchevsky, that broad of a theory of criminal liability would contravene the holdings in the Supreme Court's Chiarella and O'Hagan opinions, the former recognizing that a duty to disclose could arise in a misappropriation context, the latter applying such duty and theorizing that a person can owe a fiduciary duty to the source of material, nonpublic information.

Korchevsky’s petition summed up his argument thus: “As was true of the defendant in Chiarella, Mr. Korchevsky had no prior dealings with the investors. He was neither their agent, their fiduciary, nor a person in whom they had placed their trust and confidence. He was, in fact, a complete stranger who dealt with the investors only through impersonal and arms-length market transactions.”

The case is No. 21-580.