Under the Cover of Darkness: Insider Trading and the Dark Web
On Thursday, March 18, 2021, the U.S. Securities Exchange Commission (“SEC”) instituted civil proceedings in the United States District Court for the Southern District of Indiana against James Roland Jones of Redondo Beach, California, for selling what he called “insider tips” on the “dark web” from late 2016 into 2017. In its press release, the SEC notes that this is its “first enforcement action involving alleged securities violations on the dark web.”
Essentially, the SEC claims that Jones trolled the dark web on the Internet in search of non-public information about companies whose securities are registered with the SEC and traded either on a securities exchange (e.g., the New York Stock Exchange [“NYSE”] or NASDAQ) or on one of the trading platforms operated by the OTC Market Group, Inc. In the complaint, the SEC alleges that Jones was unsuccessful, but in the spring of 2017, “Undaunted[,] Jones began selling stock tips on the dark web by falsely claiming his tips were the product of “material non-public information“ that he obtained from the insider trading forum and/or corporate insiders.” Jones functioned much like a tout at the race track, except that in this case, the tout’s recommendations were as fictitious as a Dick Francis horse race mystery. The complaint alleges that some persons paid Jones approximately $27,000 in bitcoin for those “tips” and traded on them.
The director of the Fort Worth, Texas SEC Regional Office, which oversaw the investigation, is quoted in the press release as saying, “We have committed staff and technology to pierce the cloak of anonymity these wrongdoers try to throw over their crimes.” The press release also notes that the U.S. Attorney’s Office for the Middle District of Florida has filed criminal charges against Jones. Jones agreed, upon the filing of the SEC complaint, to accept liability for the SEC charges (subject to Court approval) and be permanently enjoined from further violations, with the issues of disgorgement and civil liability postponed.
The concept of insider trading, despite the evolving complexity of the case law in this area that created liability, hangs on a simple proposition – the purchase and sale of securities should occur on a “level playing field” where no one has a special “edge.” This concept goes back at least to the 2nd Circuit decision in SEC v. Texas Gulf Sulphur, 401 F2d 833 (2nd Cir. 1968), where corporate insiders bought stock BEFORE the company announced the discovery of the largest silver ore deposit in North America.
Subsequent case law has tried to draw lines about when someone with non-public knowledge, who has a fiduciary obligation to third parties, may warn them to avoid a loss, Dirks v. SEC, 463 U.S. 646 (1983), and when someone with no fiduciary, employment, or other relationship to an issuer may nonetheless not trade on non-public information, U.S. v. Chiarella, 445 U.S. 222 (1980) (financial printer convicted of theft for trading on information learned as he was printing merger documents), and U.S. v. O’Hagan, 551 U.S. 642 (1997) (attorney for a company being acquired traded on that information before public disclosure of the deal). These concepts are codified in SEC Regulations including Rule 10b-5 and Regulation FD (for Fair Disclosure). But apparently, before the Jones case, the SEC had not had to deal with someone purporting to sell phony “insider information” on the “dark web,” whether or not accurate. Fraud is fraud even if done outside of public view, and the Dark Web is certainly outside of public view.
The Dark Web
When the average person thinks of the internet, their reference point is the Surface Web, which is indexed by conventional search engines like Google or Bing. However, the Surface Web, which most of us use every day, is less than 5% of the internet. Any activity in which you engage on the Surface Web can be – and most likely is – being tracked. Shopping for a tent and being indecisive regarding your purchase? It’s amazing how tent advertisements keep popping up while you are browsing.
Below the Surface Net, where daily legitimate personal and business interactions are conducted, lies the Deep Web, which sounds ominous but is really just the internet location for protected information such as medical records, bank accounts, government databases, and private emails, to name a few. Usually, without passwords or authorization, a person cannot access information stored on the Deep Web. The Deep Web accounts for approximately 96% of the internet. And it is within a small section of the Deep Web that the Dark Web exists.
The Dark Web is an intentionally hidden area of the internet – a dangerous neighborhood known for illegal activity and unsavory characters, where a person can buy and sell anything with total anonymity. Forget about using Google or Chrome to access this neighborhood – you need special software to gain access to the confines of this protected and uncensored space.
Ironically, the United States Government created the most commonly used software, known as Tor (“The Onion Router”), and released it to the public for free in 2004. Tor uses multiple layers of encryption (like an onion) to transmit information through indirect means to the ultimate destination, thereby preserving anonymity.
Under the Cover of Darkness
Searching for hackers for hire, illegal drugs, terrorist propaganda, stolen identities, tools to deploy ransomware? Well, look no further than the Dark Web. It was here where James Roland Jones believed his illegal, anonymous insider trading activities scam would yield significant monetary payouts without detection by the authorities. To that end, Jones sold phony insider information in exchange for Bitcoin, a decentralized virtual currency which, like the Dark Web itself, is shrouded in anonymity.
But somehow, something went wrong. Jones’s identity and actions, supposedly protected by the Dark Web, were unveiled by governmental agencies. Jones’ arrest and the SEC’s subsequent announcement of increased enforcement of such crimes perpetrated on the Dark Web cast doubt on the belief that all activity in that forbidden neighborhood is largely beyond the reach of law enforcement. Whether Jones’s downfall was inadvertent human error that revealed his identity in some fashion or the use of law enforcement cyber techniques that ultimately unmasked Jones, is yet to be determined. However, at the end of the day, you just never know who you are talking to on the Dark Web, and that thought alone should have given Jones pause.
Business lawyers at Norris McLaughlin are knowledgeable about securities laws AND efforts to conceal identity. As Justice Brandeis said so well in a 1913 Harper’s Weekly, “Sunlight is the best disinfectant.”