Reversing last year's District Court decision, the Second Circuit this week held that brokerage houses may not restrict the early distribution of their own stock recommendations under the “hot news misappropriation” doctrine. The decision in Barclays Capital Inc. et al. v. Theflyonthewall.com, Inc. (2d Cir., June 20, 2011) held that the plaintiffs' claims were preempted by the Copyright Act. While the 71-page decision does not kill the hot news misappropriation doctrine entirely, it does raise a high bar for those who seek to restrict distribution of time-sensitive factual information in the future.  

The case centered on equity analysis reports generated by research departments of the plaintiff companies (the Firms). The most significant “actionable” reports for investors are those that upgrade or downgrade the firm's rating of a security (Recommendations). Most Recommendations are issued between midnight and 7:00 a.m. and, as the Second Circuit noted, “tend to be self fulfilling prophecies” that move the price of a stock significantly during early trading hours on the same day. This is so “[i]rrespective of the quality of the particular report and Recommendation.” Id. at 45 n. 28. The Firms distribute these reports on a restricted basis to their clients early in the morning and follow up with personal outreach to them, recommending a trading strategy and inviting the client to place an order through the firm. It is through these orders that the Firms realize the revenue payoff for the investment in creating the equity research reports.

The defendant operates an online subscription newsfeed, which includes reports of Recommendations issued by the Firms that morning. In the District Court, the defendant was found liable for copyright infringement due to its copying of some of the text of the Recommendations, but those copyright infringements were not involved in the appeal. The main issue was the defendant's systematic early posting of headlines and very brief summaries of the Recommendations, in which the plaintiffs did not seek to enforce copyright.

In March 2010, Judge Denise Cote of the Southern District of New York applied the hot news misappropriation doctrine first enunciated in International News Service v. Associated Press, 248 U.S. 215 (1918) (INS), and entered a limited injunction preventing the defendant from publishing news of the Recommendations until 30 minutes after the opening of the New York Stock Exchange or, for Recommendations issued during the day, for two hours after release by a Firm. The District Court held that “the ‘hot' news doctrine is concerned with the copying and publication of information gathered by another before he has been able to utilize his competitive edge.” Fin. Info., Inc. v. Moody's Investors Serv., Inc., 808 F.2d 204, 209 (2d Cir. 1986), and applied a five-part test for hot news misappropriation enunciated in National Basketball Association v. Motorola, Inc., 105 F.3d 841, 845 (2d Cir. 1997) (NBA). Judge Cote found that the defendant had engaged in “free riding” on the Firms' equity research, and that by publishing the Recommendations at the very moment when the Firms stood to profit by them, they were reducing the incentive of the Firms to produce the reports such that their existence or quality would be threatened. In deciding that the misappropriation doctrine was applicable, the District Court did not separately consider the First Amendment or whether the plaintiffs' claims were preempted under Section 301 of the Copyright Act, which prohibits state law claims that are “equivalent to any of the exclusive rights within the general scope of copyright.”

The appeal attracted significant interest in both the financial, news reporting, and online communities, and attracted eight amicus briefs. The brief from Google and Twitter proposed that the hot news doctrine be extinguished entirely. While the Second Circuit did not go quite that far, it noted that the INS decision is “no longer good law” because it purported to apply federal common law, which was abolished in 1938 by Erie Railroad Co. v. Tompkins, 304 U.S. 64 (1938), and that the tests for misappropriation and explanations of those factors in NBA were essentially dicta and not a “statutory command.” The Second Circuit also rejected the “biblical” rhetoric in misappropriation cases about the “unfairness” of “reaping where one has not sown.” In a remarkable break from nearly 100 years of doctrine, the Second Circuit held that

unfairness alone is immaterial to a determination whether a cause of action for misappropriation has been preempted by the Copyright Act. The adoption of new technology that injures or destroys present business models is commonplace. Whether fair or not, that cannot, without more, be prevented by application of the misappropriation tort.

(By contrast, only three years ago, after having certified to the New York Court of Appeals a question concerning the proper scope of New York law of misappropriation, the Second Circuit adopted the New York court's decision, which had explained “the doctrine of unfair competition, whose basic principle is that commercial unfairness should be restrained whenever it appears that there has been a misappropriation, for the advantage of one person, of a property right belonging to another.” ITC, Ltd. v Punchgini, Inc., 9 N.Y.2d 467, 478 (2007), adopted, 518 F.3d 159 (2d Cir. 2008).)

On the issue of preemption, the Second Circuit had little trouble finding that the Firms' report fell into the subject matter of copyright and that the Firms were seeking to assert a right equivalent to that of a copyright owner, i.e., to prohibit copying and distribution. In the Court's view, the fact that the defendant was distributing only an uncopyrightable fact taken from the copyrighted report (i.e., the Recommendation itself), did not undermine the “subject matter” element of preemption, since “copyrightable material often contains uncopyrightable elements within it, but Section 301 preemption bars state law misappropriation claims with respect to uncopyrightable as well as copyrightable elements, if the work as a whole satisfies the subject matter requirement” (quoting NBA, 105 F.3d at 849. )

The Court acknowledged that, under NBA, a claim that met both the “subject matter” and “scope” requirements could still survive preemption if the claim included an “extra element” beyond mere reproduction. NBA had held that the “extra element” could be found if the factual information was time sensitive, the defendant was free-riding, and the existence of the plaintiffs' product was threatened by the defendant's practices. Id. at 853.

Here, in the nub of the decision, the Second Circuit held that there was no “free riding.” The defendant (Fly) is merely “collecting, collating and disseminating factual information...and attributing the information to its source. The Firms are making the news; Fly, despite the Firms' understandable desire to protect their business model, is breaking it.” The Court said that this is not a case like INS, in which the defendant is passing off the plaintiffs' work as its own; rather, it is reporting independently newsworthy information concerning the Firms' Recommendations, with attribution to the company making the recommendation. This, said the Court, is no different than reporting that The New York Times had endorsed a candidate or the score of an NBA game. The outcome might have been different had Fly simply aggregated and republished the content and analysis of the Firms' Recommendations, but Fly instead was collecting and publishing independently newsworthy information likely to influence markets.

Nor did Fly compete with the Firms for brokerage commissions. While the defendant's practices diminish the revenue potential arising from the subsequent trade commissions that the Firms seek to earn, the court held that “it is not at all clear that that profit is being in any substantial sense ‘diverted' to Fly by its publication of Recommendations news. The lost commissions are, we would think, diverted to whatever broker happens to execute a trade placed by the recipient of news of the Recommendation by Fly” (emphasis in original).

With this decision, the Second Circuit has interpreted the 20th century misappropriation doctrine in light of the 21st century world of instant Internet connectivity. The Court showed a preference for free dissemination of information over protection of a business model based on restricted distribution of information. The decision is likely to stand as a significant milestone in encouraging the free distribution of publicly available information. In the Second Circuit at least, those companies whose business models are based on restricted access to information will need to protect those models by contract or under the trade secret laws, since the misappropriation doctrine is now less likely to provide much protection.