The Second Circuit recently issued its long-awaited decision in Barclays Capital Inc. v. Theflyonthewall.com, Inc. The Court’s lengthy opinion is available here. The case centers on whether a website is liable for the tort of “hot news” misappropriation under New York law due to its publishing of securities recommendations issued by leading financial institutions. A Second Circuit panel reversed the District Court, which held for the plaintiffs. The panel decision, while leaving hot news misappropriation potentially viable in future cases, held that the Copyright Act preempts the misappropriation claim in this case. The majority opinion was authored by Judge Sack, who was joined by Judge Pooler. Judge Raggi filed a concurring opinion.
The plaintiffs are Barclays, Merrill Lynch, and Morgan Stanley. The plaintiffs hire analysts to perform research on securities so that they can issue recommendations to clients as to whether to hold, sell, or buy the securities. The financial institutions issue these recommendations in reports, which they typically provide before the start of trading. Although they do not charge clients a fee for the reports, the expectation is that clients that heed the advice given in the securities recommendations will employ the same financial institution that issued the recommendation as a broker. The brokerage fees that the reports generate has traditionally made them a profitable endeavor.
The defendant, the website Theflyonthewall is a news aggregator that the plaintiffs view as undermining their business model. Among the items that Theflyonthewall publishes to subscribers are the securities recommendations issued by the plaintiff financial institutions. Theflyonthewall credits the financial institutions that provide the recommendations in its reporting. At times, it has published the recommendations before the financial institutions make them available to their clients. (The financial institutions say that they have incurred great expense to monitor employees and “plug” leaks to news outlets such as Theflyonthewall, but have apparently not met with genuine success in keeping the information under wraps.) By publishing the securities recommendations before or shortly after the financial firms do, Fly provides an alternative means for investors to obtain the information.
The plaintiffs claim that Theflyonthewall is free riding on their work and, because the securities recommendations are time-sensitive, are liable for the tort of hot news misappropriation. The plaintiffs bring their claims under New York law, which has long recognized the misappropriation doctrine as applied to time-sensitive information. Under the plaintiffs’ theory, Flyonthewall should be prohibited from reporting securities recommendations in close temporal proximity with the firms, ensuring that it would no longer be a threat. The District Court agreed and, as noted by the Second Circuit, issued an injunction “barring Flyonthewall from reporting a Recommendation until either a) half an hour after the market opens, if the report containing the recommendation was released before 9:30 a.m., or (b) two hours after release, if the report was released after 9:30 a.m.” However, the Second Circuit granted Flyonthewall’s request for a stay of the injunction pending the outcome of the appeal.
The misapprorpiation doctrine has its origins in a 1918 Supreme Court decision, International News Service v. Associated Press. In INS, the Supreme Court considered whether INS was liable for republishing news stories issued by AP. INS routinely wired stories first published by AP on the east coast to west coast newspapers after rewriting the stories so that there would not be copyright infringement. Indeed, the Supreme Court agreed that INS was not liable for copyright infringement. Nevertheless, because INS was viewed as free riding on AP’s labor in publishing the news stories, the Supreme Court ruled that INS’s practice of publishing the stories shortly after AP made them available amount to misappropriation of a quasi-property right. Justice Brandeis issued a lengthy dissent, in which he argued that copying another’s product was an inevitable–and valuable–part of free market competition.
INS is no longer good law, because it was premised on the existence of a “general common law” (judge-made law) that the Supreme Court has largely rejected. Nevertheless, a number of states still have their own version of the tort of hot news misappropriation. Numerous academics would be quite happy for it to be consigned to the legal dustbin, and a number of judges have evinced open skepticism of the doctrine’s rationale. One perspective is that Justice Brandeis had it correct in his dissent when he argue that free riding was simply a natural form of competition. Company A makes a product, the features of which company B copies in a new, slightly different, product, and we normally view that as healthy because it increases competition and ultimately creates lower prices for consumers. And there are also significant First Amendment issues raised in misappropriation cases. Factual information, after all, is not copyrightable and is in the public domain.
In this case, the judges on the Second Circuit did not reach the First Amendment issue because they held that the Copyright Act preempted the financial institutions’ misappropriation claim. The Copyright Act expressly preempts state laws that legislate in the same field. A legal theory based on state law that falls within the scope of the Copyright Act may nevertheless survive preemption if it is based on an “extra element” that distinguishes the claim from a copyright infringement claim.
The majority and concurring opinion disagree over how to read the leading precedent in the Second Circuit on the issue of when the Copyright Act preempts a hot news misappropriation claim, National Basketball Assoc. v. Motorola, Inc. According to the majority, while the opinion in NBA purported to establish a five-part test for the viability of a misappropriation claim, this was in reality “dictum” that was not a necessary part of the decision. Judge Raggi disagrees, and would have held that the five-part test applied in this case as well. The majority opinion concludes that because Flyonthewall was not free riding, it follows that it cannot be held liable for hot news misappropriation. Judge Raggi would hold that Flyonthewall is free riding on the plaintiffs’ reports, but that because Flyonthewall is not in direct competition with the brokerage houses, it is not liable under the previous test put forth by the Second Circuit in NBA.
In NBA, the Second Circuit recounted INS and framed the issue as to the extent to which misappropriation claims remain viable after the 1976 passage of the Copyright Act. The Court then concluded:
We hold that the surviving “hot-news” INS-like claim is limited to cases where: (i) a plaintiff generates or gathers information at a cost; (ii) the information is time-sensitive; (iii) a defendant’s use of the information constitutes free-riding on the plaintiff’s efforts; (iv) the defendant is in direct competition with a product or service offered by the plaintiffs; and (v) the ability of other parties to free-ride on the efforts of the plaintiff or others would so reduce the incentive to produce the product or service that its existence or quality would be substantially threatened.
The NBA Court later restated these five elements for a post-INS misappropriation claim. In restating the elements, the Court added a quotation from INS in support of the fifth element, referencing the Supreme Court’s statement in that case that INS’s business practice, if left unchecked, would render AP “profitless or so little profitable” that AP’s service would be cost-prohibitive. Besides stating the elements of a misappropriation claim, the Second Circuit in NBA identified three elements that distinguished a misappropriation claim from a copyright claim such that the misappropriation claim is not preempted by the Copyright Act:
We therefore find the extra elements — those in addition to the elements of copyright infringement — that allow a “hot-news” claim to survive preemption are: (i) the time-sensitive value of factual information, (ii) the free-riding by a defendant, and (iii) the threat to the very existence of the product or service provided by the plaintiff.”
Comparing the three elements that the Court identified above to the five-part test for misappropriation, the NBACourt did not identify the cost of gathering information or the requirement that there be direct competition from the five-part test. But these elements exist in cases involving copyright infringement, so that makes sense. As the Second Circuit correctly identifies in this case, the five-part test and three-part test were for different things. The five-part test states the elements for the tort of misappropriation. The test for whether preemption applies contains three parts, which overlap with three of the elements that must be present for the tort to apply. Thus, under the framework given in NBA, a claim may be not preempted but still fail because of one of the five elements of the tort is absent.
In Flyonthewall, the majority opinion discards the five-part test that the Court enunciated in NBA. The majority states that the Court’s recitation of the test is not entirely consistent, because the supporting language from INS could be read to change the meaning of the fifth element of the test. (The majority compares the language of the fifth element–”substantially threatened”–with a business practice that would render a competitor “profitless” or of such little profit that it would go out of business.) But the majority’s more important contention is that the five-part was dictum because, after all, the NBA Court identified only three elements as necessary to overcome a preemption challenge. While the Court also identified the elements of the misappropriation tort in its five-part test, the real legal issue was the preemption issue, and the majority in Flyonthewall therefore characterizes the five-part test as dictum.
It is slightly curious that the majority embarks on this path. All of the parties to the case proceeded on the basis that the five-part test from NBA was controlling in this case. And, because the Court concluded that Flyonthewall was not free riding, it did not need to engage in this analysis to reach the conclusion it did. In any event, under the majority’s analysis, the existence or absence of free riding is the key inquiry as to whether a misappropriation claim can proceed.
And the majority makes clear that a news report that credits the original source is not free riding. The majority indicates that in the news business free riding involves taking information that a competing company has acquired and then reporting that information as the company’s own without attribution. In this case, Flyonthewall credited the original financial institutions for issuing the securities recommendations; it did not pass off the securities recommendations as its own. Furthermore, under the majority’s analysis, Flyonthewall is protected because the financial institutions have not acquired the recommendations as part of their reporting, but have “created” them. The majority states:
The Firms here may be “acquiring material” in the course of preparing their reports, but that is not the focus of this lawsuit. In pressing a “hot news” claim against Fly, the Firms seek only to protect their Recommendations, something they create using their expertise and experience rather than acquire through efforts akin to reporting.
Under the majority’s analysis, a firm that is “creating” news rather than “breaking” news cannot press a claim for misappropriation. Put slightly differently, the recommendations that the firms issue are a legitimate subject of a news story, and are not themselves a report about the news of the day. The majority reasons that the financial institutions’ behavior in this case differs greatly from that of AP in INS because AP was issuing factual news stories, not creating news stories.
There is some language in the majority opinion that suggests that news stories that attribute the source of their information, even in cases involving strictly factual news reports, are not liable for misappropriation. In a footnote, the majority gives an example of a report by PBS that referenced AP and other news sources as revealing that Solicitor General Elena Kagan was President Obama’s choice to become the next Supreme Court Justice.
In sum, the majority construes the free riding requirement such that there must be copying of a news story that was acquired, not created, for a hot news claim to proceed. Whether attribution in the case of factual stories will be enough to defend against a misappropriation claim was not directly addressed in the opinion, even though it seems that in many cases it will be sufficient to avoid the free riding category.
Judge Raggi agrees with the majority that the Copyright Act preempts the misappropriation claim, but her analysis differs from the majority in several significant ways. First, she would have adhered to the framework set forth by the Second Circuit in NBA, including the five-part test for misappropriation. She is unconvinced by the distinction the majority draws between acquiring and creating news, and views Flyonthewall as free riding.
However, Judge Raggi concludes that the financial institutions and Flyonthewall are not in direct competition, arguing that for two firms to be in direct competition for purposes of a misappropriation claim, the firms must be in the “keenest” of competition. Judge Raggi states that “[T]he critical consideration for purposes of identifying direct competition is the substantial similarity of the products in satisfying relevant market demand.” Judge Raggi argues that differences in the business models and customers served by the financial institutions and Theflyonthewall support her conclusion that there is not direct competition in this case. Because the majority based its analysis on what it argued was the absence of free riding, it did not reach the question of whether there was direct competition.